Looking past the large upward revision to November 2014 nonfarm payrolls, you might have noticed that the U.S. economy has entered, in the words of the Federal Reserve’s version of Chance, the Gardener, Alan Greenspan, a “soft patch”. In recent months, labor conditions have weakened, manufacturing activity has hit a wall, consumer spending has waned and residential real estate demand has sunk. This “soft patch” is illustrated in Charts 1,2,3 and 4, which contain representative data that will not be revised radically, if at all.

Chart 1

Chart 2

Chart 3

Chart 4

I believe this current weakening in the pace of U.S. economic activity is primarily the result of the past sharp deceleration in the growth of thin-air credit, thin-air credit being defined here as the sum of commercial bank credit and reserves of depository institutions held at the Federal Reserve. As I have argued ad nauseam, there is a positive correlation between lagged values of thin-air credit growth and the growth of economic activity. Chart 5 shows the behavior of thin-air credit in the 12 months ended January 2015 in terms of its three-month annualized growth and its month over year-ago month percent change. There was a noticeable deceleration in the growth of thin-air credit in October, November and December 2014, followed by a sharp re-acceleration in January 2015.

Chart 5

Chart 6 shows the behavior of the two components of thin-air credit in terms of their three-month annualized percent changes.

Chart 6

With the cessation of Fed QE securities purchases in October 2014, the Federal Reserve component of thin-air credit, depository institution reserves held at the Fed, has entered an outright contractionary phase. But at the same time that the Fed’s contribution to thin-air credit has been diminishing, commercial banks’ contribution has been increasing. The acceleration in commercial bank credit in the three months ended January 2015 has largely been responsible for the re-acceleration in year-over-year and three-month annualized growth in total thin-air credit in January 2015.

Barring a sharp deceleration in commercial bank credit in the next several months, a re-acceleration in total thin-air credit growth should be sufficient to extricate the U.S. economy from its current “soft patch”. So, to paraphrase Chance, the Gardener: “Yes, there will be stronger growth in the U.S. economy in the spring.” The current economic-activity “soft patch” likely has the FOMC leaning toward making no monetary policy changes at its June 16-17 meeting. If the pace of economic activity picks up in the second quarter, as I expect, the lag in the reporting of economic data might still stay the FOMC’s hand in June. If I am right about a spring pick-up in the pace of economic activity, however, look for some overt FOMC tightening action at the July 28-29 meeting.

The dramatic retreat in the price of oil and other commodities has muddied the waters for those trying to assess inflation. The world’s central banks, most of which are charged with meeting an inflation target, are among those struggling to gain adequate visibility.

Recently, Bank of England (BoE) Governor Mark Carney laid out some interesting principles to help “look through” current distortions and arrive at the correct perspective. By separating transitory factors from those that are more permanent and drawing a distinction between good disinflation and bad disinflation, he offered a framework for others to follow.

January data on prices for the United Kingdom showed that the headline inflation level was again dragged downward by lower oil and food prices. The increase in Britain’s overall consumer price index (CPI) now stands at a record low of 0.3% over the past year. This reading is likely to turn negative, perhaps as early as next month. Similar developments are being seen in other economies, to a greater or lesser degree.

The BoE fully expects a brief spell of overall deflation and yet does not seem concerned. During the press conference following the quarterly inflation report last week, Carney stressed his belief that a brief period of lower prices is unambiguously good for the British economy and that the United Kingdom is far from falling into pernicious deflation wherein consumer purchases are consistently delayed. How has he arrived at this conclusion and why is the bank seemingly so relaxed?

Firstly, the bank has broken down the CPI into its component parts and studied each individually. An interesting statistic raised during the press conference was that 68% of the components of the U.K. CPI basket are still rising in price, which is in line with historic averages. Further, the year-over-year rate of core inflation (which excludes energy and food prices) rose to 1.4% in January. These are hardly signs of a deflationary spiral.

Secondly, Carney was very careful to distinguish between a temporary fall in the oil price and widespread price changes across the economy, at which point a “good price fall” would become a “bad price fall.” In the former case, a limited period of falling prices for some items adds to consumption and economic momentum. Estimates suggest there is now an extra £10 billion in the British economy that can be spent on goods other than petrol, which will boost growth. And as this occurs, prices will resume a more normal pace of increase.

Thirdly, Carney outlined the underlying strength of the economy as a strong check against broad deflation. In this regard, he pointed to continued declines in unemployment, which he suggests could fall to 5% over his forecast period. The BoE was bullish when it came to wage growth, upping its forecast to 3.5% for 2015. If the cost of labor rises at this rate, a drop in the overall CPI would be very unlikely.

It is partly because of these strong fundamentals that the BoE changed its inflation forecast looking ahead to 2018. CPI growth is set to remain around zero for the rest of this year, but once temporary effects have dissipated and slack in the economy has been reduced, inflation could rise faster than previously anticipated, to just above the 2% target at the end of 2017.

Taking this longer view is the proper perspective for those setting monetary policy. By publishing a higher level for the end of the forecast period, the governor may be subtly trying to change market expectations for a rate hike by shifting focus away from what is happening to prices now and toward the solid recovery.

Other central banks are also attempting to look through temporary price effects. The most recent minutes of the Federal Open Market Committee and the first minutes from the European Central Bank (ECB) governing council meeting reflected concerns about persistently low levels of inflation, prompted in part by the energy price correction.

Forecasts from the Federal Reserve have consistently reflected an expectation that inflation is on its way back toward the long-term target of 2%. If the benefits of low prices for some products add to existing economic momentum, the price level should resume a normal rate of increase after this transitory period of muted growth. And similar to the case in the United Kingdom, service-sector inflation (which makes up 62% of the U.S. CPI) is on a normal track.

The dynamic in the eurozone is more complicated. The ECB proceedings reflected concern that a widening share of goods and services is showing price declines, and underlying economic momentum is insufficient to serve as a check against deflation. As a result, the minutes note that “(T)he Governing Council was not in a comfortable position to ‘look through’ price shocks, even when they originated on the supply side.”

In sum, the inflation construct offered by Governor Carney last week may prove to be a very valuable British export to the rest of the world. One also hopes that Britain’s strong economic performance will prove valuable to its neighbors in Europe.

Oiling the Gears of Consumption

Crude oil prices have declined by more than 50% since June 2014, and gasoline prices in the United States are down roughly 22%. It is widely expected that the benefit from lower gasoline prices should translate into higher consumer spending on other items. Analysts are slicing and dicing data to look for signs of this oil price dividend.

U.S. real consumer spending advanced at a robust 4.3% annualized pace in the fourth quarter, a solid reading that is a testimony to improved economic fundamentals. But the weakness in December and January retail sales after excluding gasoline purchases has many wondering if consumers are saving energy cost reductions for a rainy day.

At first, consumers increase gasoline purchases when prices fall, and this is visible in recent data. In the June-December 2014 period, real gasoline sales rose 3.9%. Households are also inclined to buy new cars, with a preference for bigger vehicles, when gasoline outlays make up a smaller part of the budget. Recent car sales numbers support the view that the reduction in gasoline prices boosted car sales, especially for larger models.

Looking at consumer spending beyond fuel and transportation, data indicate that restaurant sales, a discretionary purchase, recorded the largest six-month increase since 2006. But outside of these primary categories, spending has maintained a more modest upward trend.

Household preferences may be leading to frugality — for now. Personal saving as a percent of disposable income held nearly steady on an annual basis in 2014, while quarterly numbers point to a drop in savings. Many families still have some work to do to pay down debt and rebuild savings, and this may be holding back their willingness to spend their energy cost windfall.

Further, the Permanent Income Hypothesis posits that consumers have a long-term trajectory in mind when they allocate their budget. In this context, if the recent drop in oil prices is seen as a transitory event, a portion of the resulting savings may not be spent. On that front, the University of Michigan Consumer Sentiment survey shows households expecting a 25% increase in gasoline prices during 2015.

However, as time goes on and the sense deepens that gasoline prices will remain lower for longer, gains in consumer expenditures should be more prominent. This would follow the lagged pattern seen in past oil price corrections. If gasoline prices eventually reflect the full correction in crude oil prices, this would also be an accelerant for the economy.

These considerations are included in our forecast of consumer spending for 2015, with the first half showing a stronger performance compared with the latter part of the year. The benefit from lower oil prices is here, but the size is smaller than expected — for now.

So while cheap gas has not produced a very substantial change in consumer behavior yet, this remains an important upside factor in the outlook for 2015.

Audit This

I sit on the same floor as our audit department. It’s a bit nerve-wracking; I am always in fear that one of its members will notice something questionable on my desk and demand a lengthy explanation. Broadly speaking, though, I have immense respect for my partners across the hall; events over the past 25 years have clearly demonstrated the importance of their discipline to the financial system.

Nonetheless, I am adding my voice to the expanding chorus that stands against the “audit-the-Fed” movement. The proposal is a thinly veiled attempt by some in Congress to meddle in monetary affairs, cloaked in the false tunic of the public interest.

The Federal Reserve has attracted a lot of attention since 2008. The series of steps taken to stabilize the financial system and re-establish economic expansion pushed the envelope of central bank authority. As one reflection of this, the Federal Reserve’s balance sheet remains more than five times larger than it was prior to the Global Financial Crisis.

As the owner of about 14% of all U.S. Treasury securities and 24% of U.S. agency-backed mortgage bonds, the Fed has also been generating sizeable cash flow, well beyond what is needed for its functioning. The excess is remanded to the Treasury Department, a practice that produced nearly $100 billion for federal coffers last year.

Such powers and such sums certainly warrant appropriate oversight. To that end, the Federal Reserve is already audited on a number of fronts. Its financial statements are reviewed by one of the “Big Four” accounting firms, and its operations are reviewed by the General Accounting Office (GAO). Having participated in some of the GAO exercises while working at the Fed, I can attest to their depth and objectivity.

Of course, it is not the bookkeeping or the process reviews that interest the Fed’s critics in Congress. Instead, they would like to expand legislative oversight of monetary policy by retrospectively reviewing central bank decisions and the outcomes they produced.

Aside from the bald politics of the proposal, the concept has serious flaws. Decisions made in real-time under uncertainty are hard to judge ex post when all is clear. Further, monetary policy works with long and unpredictable lags; choosing an appropriate time line for review is, therefore, difficult. And finally, economic outcomes are the product of a wide series of domestic and international policies over which the Fed has only limited control.

Structurally, the independence of central banking is a very sacred tenet in the financial world. Excessive government involvement in the process can stress short-term outcomes over long-term goals and raises the prospect of the central bank monetizing public debt. There have been numerous past and present examples from around the world that illustrate these dangers.

Over the past generation, the Federal Reserve has become progressively more open in explaining its actions. Next week, Fed Chair Janet Yellen will deliver the Fed’s semiannual monetary report to the Congress, one of a series of regular efforts to keep the public fully informed.

She is far too polite to be so direct, but many of us would cheer if she parried the calls for greater accountability by turning the mirror back on those who would question her. Now that’s an audit I’d like to see.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

This picture is the story of many investors’ lives, providing they were investing 20-25 years ago. While younger investors may not be able to “feel” the similarities between today’s investor environment and that of the late 1990s buildup to the Nasdaq Composite hitting the 5000 level, those of us who remember it probably remember the feeling. The air was sweeter, the money greener, and a sense of serenity existed which was akin to getting a 2-hour massage…that lasted for years.

Nasdaq 5000 first occurred in March of the year 2000. It is knocking on the door again. At Sungarden, we are not in the prediction business but we ARE in the business of evaluating reward vs. risk tradeoffs. And they are tilting ever so gradually toward higher risk and lower reward for traditional investment approaches. And like what followed Nasdaq 5000 the last time, we would not expect a bell to sound signaling an end to the stock bull market we have had since around this time in 2009. And in our own portfolios, we are still enjoying the ride higher, in our own “hedged investing” way. But caution flags abound. Here is what we see, in reference and deference to that old, great bubble of a market that that ended in early 2000 and, for the Nasdaq Composite Index, marked the start of a 16-year period in which your return was about zilch.

Technology stocks were at the top of minds, media and portfolio weightings. Today they are not called “internet” stocks as they were back then. But ask a novice investor about their portfolio, and the same emerging tech names tend to blurt out.

Private companies are being valued at levels that seem foolhardy to value-oriented investors like us…but we are probably in the minority, and too old and dumb to really understand this new era all of the millennial investors have figured out how to conquer. Hey, where is Stuart, that red-hed kid from the E-Trade commercial from the late 1990s, when you need him (if you get the reference, you definitely remember the dot-com bubble!).

Investing in the stock market still works like it used to on the surface…but the players and forms in which it comes in have changed. ETFs, High-Frequency Traders, Hedge Funds, etc. are all a bigger force than at the time of the first Nasdaq 5000. But investor hubris? That’s still there. The biggest difference is that today, someone’s opinion can be known by millions in a second. Back then, you might find out faster than a newspaper, but only if you had one of those newfangled AOL accounts. Geez, I sound like that guy at Disney’s “Carousel of Progress” ride, don’t I?

One thing that was not the same back then: high-quality bond rates. Back then, 10-year U.S. Treasury Bond yields started with a 6. Today they start with a 2. All that means is that if Nasdaq 5000 turns out to be another last gasp in an over-levered economy, and not the launching pad for a new era of wealth creation, a major cushion for equity investors is gone. That will require a different escape plan for investors. That’s what we are focused on managing here.

The Chinese New Year, which kicks off today, is the largest and most widespread cultural event in mainland China, bringing with it massive consumer spending and gift-giving. During this week alone, an estimated 3.6 billion people in the China region travel by road, rail and air in the largest annual human migration.

Imagine half a dozen Thanksgivings and Christmases all rolled into one mega-holiday, and you might begin to get a sense of just how significant the Chinese New Year festivities and traditions are.

According to the National Retail Federation, China spent approximately $100 billion on retail and restaurants during the Chinese New Year in 2014. That’s double what Americans shelled out during the four-day Thanksgiving and Black Friday spending period.

As I’ve discussed on numerous occasions, one of the most popular gifts to give and receive during this time is gold—a prime example of the Love Trade.

Can’t Keep Gold Down

Most loyal readers of my Frank Talk blog know that China, along with India, leads the world in gold demand. This Chinese New Year is no exception. Official “Year of the Ram” gold coins sold out days ago, and since the beginning of January, withdrawals from the Shanghai Gold Exchange have grown to over 315 tonnes, exceeding the 300 tonnes of newly-mined gold around the globe during the same period.

China, in other words, is consuming more gold than the world is producing.

What’s not so well-known—but just as amazing—is that China’s supply of the precious metal per capita is actually low compared to neighboring Asian countries such as Taiwan and Singapore.

This might all change as more and more Chinese citizens move up the socioeconomic ladder. Over the next five years, the country’s middle class is projected to swell from 300 million to 500 million—nearly 200 million more people than the entire population of the United States. This should help boost gold bullion and jewelry sales in China, which fell 33 percent from the previous year.

“I don’t see demand staying down because you have had structural changes,” commented WGC Head of Investment Research Juan Carlos Artigas in an interview withHard Assets Investor. “One of them, emerging market demand from the likes of India and China, continues to grow, and we expect it to continue to grow as those economies develop further.”

New Visa Policy Promises Increased Chinese Tourism

The Year of the Ram has also ushered in a new visa policy, one that has the potential to draw many more Chinese tourists to American shores.

For years, Chinese citizens could receive only a one-year, multi-entry visa. Now, leisure and business travelers can obtain a visa that allows them to enter multiple times over a 10-year period. The visa application process has also been relaxed.

In terms of overseas spending, Chinese tourists already sit in first place, just above their American counterparts. According to the United Nations World Tourism Organization, a record $129 billion was spent by Chinese travelers in 2013 alone. The average Chinese visitor spends between $6,000 and $7,200 per trip in the U.S.

This visa policy reform is an obvious boon to travel and leisure companies such as those held in our All American Equity Fund (GBTFX)—Walt Disney and Carnival Corp., for examples, not to mention retailers such as Kohl’s, Coach and The Gap.

Other beneficiaries include Chinese airlines such as Air China, which we own in our China Region Fund (USCOX). Global airline stocks are currently soaring as a result of low oil prices, increased seat capacity and more fuel-efficient aircraft. The new visa policy has the potential to give these stocks an even stronger boost.

On a lighter note, at least a couple of airports in North America are making the most of the Chinese New Year, hosting performances by Chinese musical artists and providing entertainment such as a lion dance through the terminal and calligraphy.

To our friends and shareholders here in the U.S. and abroad, I wish you all a Happy Chinese New Year!

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Stock markets can be volatile and share prices can fluctuate in response to sector-related and other risks as described in the fund prospectus.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the All American Equity Fund and China Region Fund as a percentage of net assets as of 12/31/2014: The Walt Disney Co. 1.16% All American Equity Fund; Carnival Corp. 1.18% All American Equity Fund; Kohl’s Corp. 1.17% All American Equity Fund; Coach, Inc. 1.18% All American Equity Fund; The Gap, Inc. 1.19% All American Equity Fund; Air China Ltd. 1.11% China Region Fund.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

Deep into the US earnings season, the halo from Apple’s shining performance has lit up an otherwise lackluster market. This is no consolation for the rest of the companies in the S&P 500. In this type of market, we believe investors need to be especially discriminating.

The earnings season isn’t quite over yet. But as of February 10, Apple’s fourth-quarter profit growth exceeded those of all the S&P 500 companies that have reported, combined. In aggregate, 347 companies reported a 3% contraction in earnings (Display, left). And the pain was widespread, with more than a third of S&P 500 companies showing year-over-year declines (Display, right)—as some of the biggest companies in the index dragged down aggregate earnings growth.

Bumper Quarter for Apple

Apple had an excellent quarter. It sold almost 75 million iPhones, fueling revenue growth while increasing the average selling price per unit. Strong revenues helped boost earnings by about 50%, through expanded margins as well as fewer shares outstanding due to a stock buyback program. But one healthy Apple—which accounts for about 4% of the index—isn’t really enough to keep the doctor away from the rest of the market.

Other companies reported mediocre results. We believe that several factors—including a strong US dollar, modest global economic growth and potential pressure on wages—are creating challenges for revenue and earnings growth.

Strong Dollar Cuts Revenue

Over the past year, the US dollar has strengthened by more than 10% compared with a basket of currencies. International sales represent about 35% of total S&P 500 revenues. So if the dollar strength persists, we expect it to take a bite of about 3% from overall revenue this year.

Wages are a growing pressure point in early 2015. Excess labor—resulting in modest wage gains—helped to keep profitability elevated over the past five years. But in the February 6 employment report, wage inflation exceeded 2%. If this trend continues or accelerates, it could signal a peak for profit margins.

Mixed Impact from Oil Shock

Low oil prices have had a mixed impact on the market. After plunging by about 50% from a year ago, many energy companies—which account for about 8% of the S&P 500—are feeling the squeeze. For other companies, lower energy costs are likely to help reduce expenses. And consumers will enjoy a windfall from falling energy prices, which should buoy consumer spending—as well as US and global economic growth.

Some argue that underlying profits are actually healthier than they look. We disagree. The dollar and oil shock are real factors and shouldn’t be stripped out of earnings to paint a prettier picture. In our view, investors should ask whether the sluggish earnings season is the start of a bigger trend after six strong years and a recovery of profit margins from 4.5% in 2008 to a record 10% in 2014—and should ask what it means for their portfolios.

Start by thinking about how these complex dynamics will affect diverse companies as the year unfolds. For example, pressure on margins from rising wages could be offset by better revenue growth, as consumers have more disposable income. Since every company will experience this differently, selectivity is becoming increasingly important.

Sector valuations also deserve attention. The US equity market is not a homogenous entity. Utilities and staples look expensive relative to history as the quest for yield has inflated valuations (Display). In contrast, the industrials and technology sectors appear relatively inexpensive given concerns about short-term earnings. This is a good starting point for stock pickers. Within these sectors, we believe there are undiscovered opportunities.

Be Selective

Equities still have an important role to play in investor allocations. With global bond rates at or close to record lows, investors can’t really afford to stay on the sidelines of the stock market to meet their long-term goals. That said, we believe market conditions today demand a more selective approach, as opposed to the last few years, when a diversified approach was rewarded.

With earnings growth more difficult to find today, owning a few select names is preferable to owning 500 companies via an index, in our view. In particular, we believe that companies with exposure to secular growth drivers, which are relatively uncorrelated with macroeconomic conditions, have the best chance of delivering superior results.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

James T. Tierney, Jr, is CIO – Concentrated US Growth at AB (NYSE:AB).

One investment call that most investors, myself included, got wrong last year was predicting interest rates would go up. This time around, while U.S. long-term yields have rebounded from their January lows, rates have generally been lower than where they ended 2014, calling into question: Will long rates stay low and defy expectations again in 2015? I think that is unlikely. I expect the 10-year U.S. Treasury yield higher a year from now.

Before we talk about why I think interest rates would rise, it helps to revisit some of the reasons behind the 10-year U.S. Treasury note being stuck at yielding a low 2%.

Lackluster global growth. Many economies have been struggling with well below average growth and inflation. While this phenomenon is most common among developed economies, some emerging markets also suffered from it: for example, China’s headline inflation rate recently dipped below 1%. Slow growth has led to ultra-low and often negative yields in much of the developed world, making U.S. fixed income more attractive in relative terms, even as the U.S. economy strengthens. With yield an ever-scarcer commodity, relatively high rates that U.S. bonds offer alongside a strong U.S. dollar are attracting global capital flows and pushing bond prices higher and yields lower.

Low supply, high demand. Put simply, there are not enough bonds to go around. Consumers have reined in their borrowing and governments have tried to moderate spending, which means fewer bonds have been issued. Despite the much talked about “Great Rotation” into stocks, institutional and retail investors continued to have strong appetite for bonds. Also, with central banks outside the United States undertaking large scale buying of bonds through quantitative easing, demand for bonds will probably stay high for some time.

No price growth. Although the U.S. economy accelerated last year and job creation surged, wage growth remains muted and commodity prices are plunging. This means that even in the U.S. expectations for future inflation are unusually low.

Given these market dynamics, why expect higher interest rates? Because some of these conditions are starting to change.

A nascent rise in inflationary expectations. From my vantage point, oil is likely to stabilize and inflation could return to more normal levels in the back half of 2015, pushing inflation expectations to come up from today’s very low levels. There are signals that this is already happening. Inflation expectations embedded in the 10-year Treasury Inflation-Protected Securities (TIPS) have rebounded from 1.50% in January to 1.70% today. If expectations move back toward 2%, closer to the Federal Reserve’s (Fed’s) target, this will translate into upward pressure on long-term rates.

The Fed’s “liftoff.” As we get closer to the Fed raising its benchmark rate later this year, interest rates will probably move higher. A measured tightening pace is expected, and most of the pressure will be on the short end of the yield curve. However, long-term rates will still be affected.

A strong U.S. economy. We are seeing increased credit demand from businesses and, to a lesser extent, from households as economic conditions improve in the United States. Higher demand for capital will buoy rates.

The bottom line: While we still expect the low-yield world to persist throughout 2015 and probably next year as well, U.S. long-term interest rates are likely to gradually climb back to where they were early last year… just when everyone got it wrong.

Source: Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock.

This material represents an assessment of the market environment as of the date indicated and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security in particular.

NEW YORK – When the euro crisis began a half-decade ago, Keynesian economists predicted that the austerity that was being imposed on Greece and the other crisis countries would fail. It would stifle growth and increase unemployment – and even fail to decrease the debt-to-GDP ratio. Others – in the European Commission, the European Central Bank, and a few universities – talked of expansionary contractions. But even the International Monetary Fund argued that contractions, such as cutbacks in government spending, were just that – contractionary.

We hardly needed another test. Austerity had failed repeatedly, from its early use under US President Herbert Hoover, which turned the stock-market crash into the Great Depression, to the IMF “programs” imposed on East Asia and Latin America in recent decades. And yet when Greece got into trouble, it was tried again.

Greece largely succeeded in following the dictate set by the “troika” (the European Commission the ECB, and the IMF): it converted a primary budget deficit into a primary surplus. But the contraction in government spending has been predictably devastating: 25% unemployment, a 22% fall in GDP since 2009, and a 35% increase in the debt-to-GDP ratio. And now, with the anti-austerity Syriza party’s overwhelming election victory, Greek voters have declared that they have had enough.

So, what is to be done? First, let us be clear: Greece could be blamed for its troubles if it were the only country where the troika’s medicine failed miserably. But Spain had a surplus and a low debt ratio before the crisis, and it, too, is in depression. What is needed is not structural reform within Greece and Spain so much as structural reform of the eurozone’s design and a fundamental rethinking of the policy frameworks that have resulted in the monetary union’s spectacularly bad performance.

Greece has also once again reminded us of how badly the world needs a debt-restructuring framework. Excessive debt caused not only the 2008 crisis, but also the East Asia crisis in the 1990s and the Latin American crisis in the 1980s. It continues to cause untold suffering in the US, where millions of homeowners have lost their homes, and is now threatening millions more in Poland and elsewhere who took out loans in Swiss francs.

Given the amount of distress brought about by excessive debt, one might well ask why individuals and countries have repeatedly put themselves into this situation. After all, such debts are contracts – that is, voluntary agreements – so creditors are just as responsible for them as debtors. In fact, creditors arguably are more responsible: typically, they are sophisticated financial institutions, whereas borrowers frequently are far less attuned to market vicissitudes and the risks associated with different contractual arrangements. Indeed, we know that US banks actually preyed on their borrowers, taking advantage of their lack of financial sophistication.

Every (advanced) country has realized that making capitalism work requires giving individuals a fresh start. The debtors’ prisons of the nineteenth century were a failure – inhumane and not exactly helping to ensure repayment. What did help was to provide better incentives for good lending, by making creditors more responsible for the consequences of their decisions.

At the international level, we have not yet created an orderly process for giving countries a fresh start. Since even before the 2008 crisis, the United Nations, with the support of almost all of the developing and emerging countries, has been seeking to create such a framework. But the US has been adamantly opposed; perhaps it wants to reinstitute debtor prisons for over indebted countries’ officials (if so, space may be opening up at Guantánamo Bay).

The idea of bringing back debtors’ prisons may seem far-fetched, but it resonates with current talk of moral hazard and accountability. There is a fear that if Greece is allowed to restructure its debt, it will simply get itself into trouble again, as will others.

This is sheer nonsense. Does anyone in their right mind think that any country would willingly put itself through what Greece has gone through, just to get a free ride from its creditors? If there is a moral hazard, it is on the part of the lenders – especially in the private sector – who have been bailed out repeatedly. If Europe has allowed these debts to move from the private sector to the public sector – a well-established pattern over the past half-century – it is Europe, not Greece, that should bear the consequences. Indeed, Greece’s current plight, including the massive run-up in the debt ratio, is largely the fault of the misguided troika programs foisted on it.

So it is not debt restructuring, but its absence, that is “immoral.” There is nothing particularly special about the dilemmas that Greece faces today; many countries have been in the same position. What makes Greece’s problems more difficult to address is the structure of the eurozone: monetary union implies that member states cannot devalue their way out of trouble, yet the modicum of European solidarity that must accompany this loss of policy flexibility simply is not there.

Seventy years ago, at the end of World II, the Allies recognized that Germany must be given a fresh start. They understood that Hitler’s rise had much to do with the unemployment (not the inflation) that resulted from imposing more debt on Germany at the end of World War I. The Allies did not take into account the foolishness with which the debts had been accumulated or talk about the costs that Germany had imposed on others. Instead, they not only forgave the debts; they actually provided aid, and the Allied troops stationed in Germany provided a further fiscal stimulus.

When companies go bankrupt, a debt-equity swap is a fair and efficient solution. The analogous approach for Greece is to convert its current bonds into GDP-linked bonds. If Greece does well, its creditors will receive more of their money; if it does not, they will get less. Both sides would then have a powerful incentive to pursue pro-growth policies.

Seldom do democratic elections give as clear a message as that in Greece. If Europe says no to Greek voters’ demand for a change of course, it is saying that democracy is of no importance, at least when it comes to economics. Why not just shut down democracy, as Newfoundland effectively did when it entered into receivership before World War II?

One hopes that those who understand the economics of debt and austerity, and who believe in democracy and humane values, will prevail. Whether they will remains to be seen.

Deflation, I’m sure, has been around since the dawn of man, though records going back past a thousand years are spotty, at best. Increased supply relative to demand or an abrupt shift in consumption always generates some form of price reduction. The root cause of the European Central Bank’s finally acting on its intention to begin quantitative easing is a direct result of deflation taking root in Europe. This call to action is quite pronounced considering the anxiety that the European region has regarding any uptick in prices due to historical ravaging from inflationary pressures.

Deflation is a widely used term in financial circles; however, its popularity is dwarfed by that of its brother, inflation. The average citizen is probably unconcerned about deflation and would probably be in favor of an environment that has falling prices every month. This positive mood is contingent obviously on income staying the same or rising, which cannot occur should prices and corporate profits be under pressure every month. Consider the inflationary degree of the use of “deflation” in the headlines. So far, we are on track to use “deflation” in headlines by a whopping 350% more in 2015 than 2014.

First, let’s attempt to define deflation; since knowing the term and comprehending the concept are two completely different things. There are many great ways to define it: “a period of declining prices, a lack of induced consumption based upon being rewarded for patience, a fearful pragmatic consumer more concerned with the future than the present.” All of these definitions work to some degree; however, the best technical definition I’ve heard was from Morgan Stanley: “…The origin of global deflationary pressures is an excess of desired savings over desired investment.” This describes the current form of deflation almost perfectly considering the coordination of global central banks to inject liquidity into nearly every corner of the globe to inflate assets. There are several forms of deflation (which we won’t really delve into here) such as price, credit, asset and currency. As we see it, there are at least two ingredients required for deflation: a supply-and-demand imbalance and a permeating and dominant form of fear.

The reason deflation is the “boogeyman” to economists is the psychological cycle that is set forth. The world is currently in the throes of deflationary pressures, especially in Europe and Asia. It is important to understand that this perspective is relative, as deflationary pressures for one country might appear as inflationary or disinflationary to another country.

The most well-known and recent bout of deflation has been in Japan which has been in the throes of deflation for nearly 25 years. During that timeframe, a once thriving and soon-to-be-dominant economy slipped to a distant third behind the United States and China. Japan’s decline is multi-faceted and only spells out the difficulty in pulling a country out of this vicious cycle.

For further evidence, consider the impact on yields; look at what has happened in Germany and the United States over the last 15 years. The two historical curves are derived from taking the average yields over the last 15 years and compared to current levels. Your eyes are not deceiving you, yields on the German Bund market are actually negative and the 10-year currently yields 0.46%. You could not only get a return of 0.46% annually on 10 years, but is also denominated in euros, which have lost 27% from its all-time highs and appears to be on track to lose another 10%. That combination only helps if a client is in dire need of tax losses.

Deflation is the dirtiest of “D words” for economists as it seems to defy logic, especially in free market systems where supply-demand balance is orchestrated on large changes in consumerism and corporate desire for profits. However, the culture issue must come into play when looking at cross-country comparisons. The duration of the current deflationary environment, at least domestically, appears to lie in the wage pressure that is slowly building in the system. History has shown that when output gaps shrink, demand for product increases the need for more skilled labor and employment slack begins to unwind, wage pressure can often spike and then slows to a more acceptable pace.

With consumption numbers showing resilient growth and an increased backstop in the form of balance sheet liquidity and net worth, the United States’ deflation experience may not be similar to the ones currently seen in Europe or in Japan. Deflationary and inflationary cycles always have momentum that maintains a trend long after the pressures may be abating. They also have some lagging components. Once the general public begins to use the new lexicon, it often begins its move toward the exit, allowing its antithesis to enter. Buying inflationary protection is very counterintuitive and cheap, two qualities we look for in all value-oriented plays. We believe investors should consider some positions in inflationary-protected assets.

Deflation doesn’t just impact economics and markets, but now we see it encroach on New England Patriots’ game preparation who have fully embraced deflation.

CRN: 2015-0121-4577RThis commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.

[description] => Deflation has been around ever since there was an excess supply of something or when demand had plummeted. The term “deflation” has now become mainstream in the general public’s lexicon, though the understanding of the declining economic growth that corresponds with it is often disregarded until it wreaks havoc on the consumer’s paycheck. When we see deflation permeating global economics, market movements and NFL games, the general public will become acutely aware of the other major impact from deflation, the increasing symbiotic nature of all the global economies. The Butterfly Effect of Chaos Theory is perhaps more impactful than at any time in history.
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[title] => Connecting the Dots: Procter & Gamble, the Strong Dollar, and Pepto Bismol
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What do those household-name companies have in common? Not much, other than that a huge part of the sales come from outside the US.

Really, really huge.

Collectively, the 500 companies in the S&P 500 get 46% of their sales and roughly 50% of their profits from outside the US. They are truly multinational giants.

Expanding your customer base is always a good thing, but doing business overseas is not without peril, and one of the underappreciated perils is the impact of currency movements. A stronger dollar can hurt companies that do a large share of their business overseas because sales in other countries translate back into fewer dollars.

Just ask Procter & Gamble, which reported their Q4 results last week.

P&G sold $20.16 billion of toothpaste, laundry detergent, diapers, toilet paper, and razor blades last quarter, but that was a 4% decline from the same period a year ago.

Worse yet, profits plunged by 31% to $1.06 per share, which was not only well below the $1.13 per share Wall Street was expecting but also a horrible 31% year-over-year drop. That’s bad.

What’s behind those terrible numbers? The US dollar.

“The October-December 2014 quarter was a challenging one with unprecedented currency devaluations,” said CEO A.G. Lafley.

The US Dollar Index was up 13% in 2014 and is now near a 9-year high. That strong dollar is a big millstone around the neck of US exporters, whose products are now more expensive for foreign buyers as well as negatively affecting profits once those foreign sales are converted back into US dollars.

Worse yet, Lafley said the environment will “remain challenging” in 2015.

The US dollar is now at a 9-year high and threatening to go higher. Much, much higher.

By historical standards, the US dollar is still cheap and expected to go higher by many observers, including Procter & Gamble.

P&G warned Wall Street that its 2015 sales will fall by another 5% and its 2015 profits will shrink by another 12%.

Think about those two numbers: 5% lower sales and 12% lower profits.

The strong dollar is a big problem for P&G because it gets roughly two-thirds of its revenues from outside the US, so it’s more affected by the strong US dollar than most companies, but P&G is far from alone when it comes to currency woes.

The line of companies that have warned that the strong dollar is hurting their profits is getting longer and longer.

Microsoft, Pfizer, McDonald’s, Caterpillar, United Technologies, Emerson Electric, 3M, and even Walmart have warned that the rising dollar is depressing their profits.

What does this mean to you? That a LOT more companies are going to report lower-than-expected sales and profits in 2015 and those that do will see their stock get hammered, just like P&G.

The problem is that Wall Street is blind to this profit-crushing trend.

In 2014, the S&P 500 companies collectively earned $117.02, and the median forecast of Wall Street strategists for 2015 S&P 500 earnings is $126, which is an optimistic 7.6% growth in earnings.

Unless you think that Procter & Gamble is an isolated island of trouble (and it’s not), you should be very worried that Wall Street is grossly underestimating the profit-crushing impact of the strong dollar as well as grossly overestimating corporate America’s earnings growth.

That massive disconnect between reality and the Wall Street dream world is going to translate into some very tough times for stock market investors. If you haven’t added some defense to your portfolio… you may need lots and lots of a popular Procter & Gamble product: Pepto Bismol.

Tony Sagami

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

Stites on Estates took an interesting look at retirement intentions versus retirement reality along with a reiteration of the dismal statistics about how little savings people who are working have accumulated as well as how few dollars people have put away when beginning their retirement.

First, their table with the numbers of people still working.

Then their table with numbers of people who are retired;

My hunch is that people will look at the tables and either feel good about perhaps being in the $250,000 category or they will be glad they are not the only ones in the $10,000 or less category, in fact they have a lot of company.

The above is data that you have seen before in one form or another. The other point made that is discussed less frequently is how common it is for people to plan to work into their late 60’s or early 70’s only to “retire” much sooner. I put retire in quotes there because people run into health problems that force their hand or their company runs into trouble that results in job cuts.

There are other two tables in the article that address this and they show that 35% of the people who retired in 2014 were 60 or younger and that 32% were between 60 and 64. This compares with 9% younger than 60 and 18% between 60 and 64 who expected to retire at those ages.

It is unclear whether there is any overlap of people but the tables are clear about a dispersion between expectations and reality and the consequence can be significant. It is easy to envision the scenario of someone who in their 40’s and 50’s saved a little for retirement but was more focused on their mortgage and kid’s college expenses who planned to crank up the savings rate in their 60’s and mortgage free with the intention of working until 70. Embedded in that scenario might also be the expectation for generally rising wages all the way through.

Part of retirement planning is the possibility that whatever you have in mind changes from the top down (something with your company or job) or the bottom up (your interests change or your hand is forced for health or family reasons).

If you’re reading this blog then you’re more likely to be in some of the higher categories for how much you have saved or you provide service to clients who are more likely to be in the higher categories. In that case you have some sort of plan for yourself or plans for your clients so what happens if planning for 68 becomes go time at 59? Being lucky enough to be in the $250,000 or more category doesn’t necessarily mean you are financially ready to retire nine years early. I would also add that while $250,000 may not seem like a large sum for this audience the numbers show that very few people have that much saved and so there is at least some element good fortune.

Ultimately a 60 year old who is 2/3rds of the way to their number who is forced to “retire” early will simply have to figure it out one way or another and that might be a scenario that is plausible for this audience versus having nothing saved. Someone who is 55 with $800,000 accumulated, believing they need $1.3 million at 64 who is then forced out of their job is certainly not ruined but they will need to figure a few things out.

This past weekend the Incident Management Team that I am on (this is a fire department thing) was part of the contingency plan for the Sedona Marathon in case the event turned into some sort of big emergency incident. I’m the Logistics Section Chief (trainee) and I spent the last couple of weeks arranging all sorts of resources we would need to call in if something had happened (it didn’t). I am still learning of course but a lot of bases were covered.

I think there is an obvious parallel to contingency planning for your retirement expectations. In terms of emergency preparation the marathon went smoothly but not every event does. Likewise not every retirement plan can go smoothly. Having something unexpected occur is beyond your control but having a contingency plan that covers a lot of bases is within your control.

Last week a scene unfolded in Athens, largely unnoticed by American eyes, that provided all the visual and metaphorical symbols needed to define the current state of the global economy. Hollywood's best screenwriters couldn't have laid it out any better.

Tiring of being told by self-righteous foreigners to pay for past borrowing with current austerity, the Greek people had just elected the most radically left-wing government in recent memory, whose stated goal was to tell their creditors that they were not going to take it anymore. The leadership of the victorious Syriza Party, a collection of mostly young Marxist and Trotskyite academics, had promised the Greek people a clean break from the past and an end to years of economic malaise. Although their plan seemed fundamentally contradictory (telling foreign creditors to butt out even while courting more aid), Syriza nonetheless appealed to a frustrated electorate through their dynamism and optimism.

To show that they were not just another upstart coalition that would co-opt the status quo once elected, Syriza leaders adopted the posture, vocabulary and clothing of revolutionaries. Throughout his campaign, Alex Tsirpas, the new prime minister, refused to wear a tie, thereby eschewing the most potent symbol of traditional power. When sworn in as prime minister, also with an open collar, he dispensed with the "hand on the bible" ceremony and instead invoked the spirit of fallen Greek Marxists. Since the election Syriza leaders have hot toned down their rhetoric as many predicted they would. Could it be that they actually meant what they said?

Syriza's fiery attitude has put Greece on a collision course with northern European leaders who face the political necessity of requiring Greece to repay previously delivered bail out money. In this context the first meeting between Yanis Varoufakis, the newly installed Greek Finance minister and Jeroen Dijsselbloem the Dutch representative of the so-called "troika" of lenders (The European Central Bank, the International Monetary Fund, and the European Commission), was bound to produce some drama. The meeting exceeded expectations on that front. But how it looked was perhaps more important than what was said.

In a room packed with cameras and reporters, Varoufakis strode in not just tieless and open collared, but with his shirt shockingly untucked. He ambled to his chair, and sat slouching backwards with his legs crossed like a poker player barely able to contain the glee of a winning hand. His expressions were effusive, satirical, and defiant. All he lacked were sunglasses and a couple of groupies to complete the rock star persona. To his right sat the stiff necked, buttoned-down Dutchman, who in in the words of Colonel Kurtz appeared like "an errand boy, sent by grocery clerks, to collect a bill."

The two agreed on seemingly nothing. Dijsselbloem insisted that the new Greek government live up to the austerity and repayment commitments, and Varoufakis said that the Greeks would no longer negotiate with the creditors who he believed were responsible for his country's destitution. When there was really nothing left to say, the meeting came to an abrupt end and the two executed a painfully awkward handshake. Dijsselbloem, seeming annoyed, avoided eye contact with his counterpart and left the room without looking back. On the other hand, Varoufakis, seemingly enjoying the moment, shrugged his shoulders and smiled for the cameras, as if to say "What's up with the stuffed shirt?"

What could explain these contrasting attitudes? Shouldn't the creditor, the one lending the money, and the party who will be asked for more, be in the power position? Shouldn't the borrower be in position of supplication? If you thought that, you don't understand the current way of the world. Based on the ascendancy of Keynesian "demand side" economics it is the borrower who is considered the key driver of growth. The theory holds that if the borrower stops borrowing they will also stop spending. When that happens they believe the entire economy collapses, dragging down both lenders and borrowers in the process. From that perspective, the bigger the borrower the greater his importance, and the more leverage he has with the lender. This is like the old adage: "If you owe the bank $10, that's your problem. But if you owe the bank $10 million dollars, that's the bank's problem."

Syriza knows that northern European leaders are terrified at the prospect of disintegration of the EU and the stability it provides. The goal of maintaining open and essentially captive markets for German manufacturers was the prime reason that pried open Berlin's wallet in the first place. But Syriza also understands the power that debtors have in today's world. Default leads to liquidations, which in turn leads to deflation, the biggest bugaboo in the Keynesian night gallery of economic fears. After years of bailouts of banks, corporations, and governments, debtors know that no one is ready to risk another Lehman Brothers type collapse on any level. The bar of "Too Big to Fail" has gotten progressively lower. If Greece can repudiate its debts, the temptation for larger indebted nations like Italy and Spain to do the same will be ever greater.

This understanding fuels not only the swagger of the Greek finance minister but also the attitude of the world's largest debtor, the United States of America. Although the $1 Trillion dollar plus annual budget deficits have been cut significantly in recent years (thought the national debt has exploded beyond $18 trillion), I believe the reduction is largely a function of the asset bubbles that have been engineered by the Fed's six year program of quantitative easing and zero percent interest rates. Any sustained economic downturn could immediately send the red ink back into record territory. But flush with his victory speech/State of the Union address, President Obama has adopted a bit of the Varoufakis bravado.

President Obama's newly unveiled 2015 budget includes almost $500 billion in new spending; effectively dispensing with the token austerity that Washington had imposed on itself with the 2011 "Sequester." In my opinion, the U.S. has virtually no hope of paying for all of our spending through taxation, the budget busting proposals should be viewed as a message to our foreign creditors that we plan on borrowing plenty more, and that we expect that they will keep lending for as long as we want. From a global economics perspective the United States is like Greece writ very, very large. Much like the Northern European countries, the major exporting nations around the world are terrified that their economies would be shut out of U.S. markets if their currencies were to strengthen against the dollar. I believe this has allowed America to approach its finances with impunity.

But this confidence may be leading to trouble. If the new Greek government keeps following its current course, it may ultimately be shown the door of the Eurozone. Although a "Grexit" may ultimately pave the way for a real Greek recovery, the Greeks themselves should have no illusions about how painful this journey may be. Without the purchasing power of the euro and the largesse of the creditors supporting them, the Greeks may find themselves with a basket case currency that delivers far lower living standards. If Greek government employees thought austerity was bad when it was imposed from Brussels, wait until they see how bad it's going to be when imposed by Athens. In fact, no Greek recovery will be possible until the newly elected Marxists become unapologetic capitalists.

When the Swiss National Bank decided to abruptly reverse course on its euro peg, the world should have been treated to a fresh lesson at the finite nature of creditor patience. While this message may have been lost on most observers, sooner or later this reality will sink in. When it does, the shirts will be tucked, the ties will be fastened, and knees just may start bending.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

The steep fall in international oil prices has significantly altered the economic prospects of most countries in the region in recent months. While consumers across the region are likely to gain from cheaper pump prices, the U.S. and Canada are expected to see the most improvement in domestic demand. U.S. consumer sentiment has surged recently, as the stronger labor market has also helped make consumers more optimistic. However, lower oil prices are likely to be a net negative for Canada as the country is already seeing a decline in energy exports. The Canadian labor market has also weakened recently as energy sector companies have started reducing their workforces and scaling back new investments.

In Latin America, Brazil is expected to see a stagnant economy in 2015 as well. The country’s trade account slipped into a deficit in 2014, as prices of major exports such as iron ore declined. Subdued demand from China and recession in neighboring Argentina hamper the export prospects for Brazil this year. For Mexico, the negative effect of lower oil prices is likely to be more contained as the country’s hedging policy limits the decline in government revenues. Stronger U.S. demand for manufactured goods should help Mexico offset the potential job losses in the energy sector. Colombia has launched additional fiscal stimulus to counter the losses from oil exports. The export prospects of Chile and Peru have dimmed as copper prices slipped further this month, but both countries are rolling out fiscal and monetary measures to help domestic demand.

At a Glance

United States: Helped by the steep fall in fuel prices and exceptionally low borrowing costs, the U.S. economy appears to have entered a phase of healthy growth. The pace of expansion for the second and third quarters of 2014 exceeded expectations, and most data points remained positive during the last quarter as well. The World Bank now expects the U.S. economy to grow 3.2 percent this year, which would be the fastest growth among developed countries.

Canada: The decline in oil prices could reduce the pace of Canada’s economic growth in 2015, but the country’s economy is likely to remain relatively healthy. Rising U.S. consumer demand should benefit the manufacturing sector in Canada’s central region. The Canadian dollar has declined nearly 10 percent against the U.S. dollar, which should help improve the price competitiveness of Canadian manufacturers.

Brazil: Weak external demand continues to challenge the Brazilian economy as the country reported a trade deficit in 2014, its first in over a decade. Exports declined more than expected in December, the fall accentuated by the continuing weakness in commodity prices. A meaningful improvement in export outlook is not expected in 2015 as demand from some of Brazil’s major trade partners is likely to remain low.

Mexico: While the Mexican economy will likely be negatively affected by lower oil prices, the decline should not be as severe as some of the other energy exporting countries. Nevertheless, lower oil prices could lead to job losses in the country’s energy sector and delay the much awaited reforms. At the same time, stronger U.S. consumer demand continues to lift the outlook for exports of manufactured goods from Mexico.

Chile: The outlook for the Chilean economy has deteriorated as copper prices have slipped further at the start of 2015. Copper prices have declined nearly 25 percent from the beginning of last year, denting the export prospects of Chile, which is the world’s leading producer. However, an increase in government spending has supported domestic demand and has lowered the unemployment rate in recent months.

Peru: The Peruvian economy slowed significantly during 2014 as international commodity prices weakened and the trend is expected to continue in 2015 as well. The pace of economic expansion dropped below 3 percent for the first nine months of 2014, compared to 5.8 percent for the previous year. To prevent further economic decline, the government announced a fiscal stimulus package and is increasing infrastructure spending this year.

Colombia: Though Colombia is one of the major oil exporters in Latin America, its government is confident that lower oil prices will not lead to a sharp decline in 2015 GDP growth. While acknowledging that the fall in oil export revenues could bring down the growth rate this year, when compared to 2014, the government believes the country’s diverse economy will limit the downside

UNITED STATES: ECONOMY GAINS PACE AS CONSUMER SENTIMENT STRENGTHENS

Helped by the steep fall in fuel prices and exceptionally low borrowing costs, the U.S. economy appears to have entered a phase of healthy growth. The pace of expansion for the second and third quarters of 2014 exceeded expectations, and most data points remained positive during the last quarter as well. As the domestic environment is expected to remain favorable, the World Bank and other forecasters have lifted their estimate for U.S. GDP growth in 2015. The World Bank now expects the U.S. economy to grow 3.2 percent this year, which would be the fastest growth among developed countries.

Though retail sales for the month of December were below expectations, U.S. consumer sentiment has continued to rise in recent months. An index of consumer sentiment measured by the University of Michigan is now at its highest level in over a decade. Average gasoline prices in the country are now at a five-year low and should result in meaningful cost savings for most households. As there are no major elections or policy changes to upset sentiment, it is now widely expected that consumers will spend their fuel savings on other goods and services.

Further gains in the labor market could provide an additional boost to consumer demand, if wage growth also picks up in the coming months. Average monthly job additions during the second half of 2014 were above expectations, and the most since the 2008 financial crisis. The unemployment rate has also slipped to a multiyear low, though wage growth has been only marginal so far. Average wages could increase at a faster pace as the market tightens this year. However, select states such as Texas and North Dakota where oil production was the major driver of labor market gains in recent years could see job losses if oil prices remain low for an extended period.

While mortgage rates have slipped further, it is unlikely that the U.S. housing market will sustain the growth pace in 2015. Slower construction activity after the housing market decline has reduced current supplies, and builders have also been more cautious in building inventory. This has resulted in rapid price gains in some of the most active markets, and many potential buyers have been priced out. In addition, despite the recent efforts by federal agencies to reduce the down payment for mortgages, credit standards remain tighter than they were before the crisis.

The Federal Reserve is widely expected to start hiking its target rate during the second quarter of this year. However, declining consumer prices and further weakness in global economic conditions could delay the rate hike to later in the year. In the statement released after the December meeting, the Fed was more optimistic in its economic growth outlook. At the same time, the statement also detailed concerns about risks to global growth.

CANADA: GROWTH RATE TO MODERATE ON LOWER OIL EXPORT REVENUES

The decline in oil prices could reduce the pace of Canada’s economic growth in 2015, but the country’s economy is likely to remain relatively healthy. Oil production in Canada’s northern region is likely to fall as the cost of production, especially from oil sands, is much higher than for other methods of extraction. Crude oil exports declined nearly 10 percent in November from a year ago, in revenue terms. Canadian oil producers have not yet reduced production, but could be forced to do so if prices remain low in the coming months. In any case, new investments in oil exploration and production are likely to fall as producers look for cost savings.

However, rising U.S. consumer demand should benefit the manufacturing sector in Canada’s central region. The Canadian dollar has declined nearly 10 percent against the U.S. dollar, which should help improve the price competitiveness of Canadian manufacturers. Lower fuel prices could also boost domestic consumption in Canada, and help both the manufacturing and services sectors. However, domestic demand is likely to remain restricted in the short term as the country’s job market has weakened. The economy lost jobs in November and December, and the unemployment rate worsened marginally. Retail sales in October were nearly unchanged from the previous month.

The Bank of Canada continues to maintain its benchmark rate unchanged, though the bank has become less optimistic about the growth outlook. However, even after the strong rebound in recent years, the country’s housing market remains buoyant. Average home prices for 2014 rose nearly 7 percent through November, easily outpacing the gains for the previous year. The central bank has repeatedly stated its concerns about price gains in the housing sector, which the bank estimates is overvalued by 20 percent to 30 percent. However, if the labor market weakens further and wage gains stall, the housing market could also be negatively affected even if mortgage rates remain at record lows.

BRAZIL: ECONOMIC GROWTH TO REMAIN STAGNANT ON WEAK COMMODITIES

Weak external demand continues to challenge the Brazilian economy as the country reported a trade deficit in 2014, its first in over a decade. Exports declined more than expected in December, the fall accentuated by the continuing weakness in commodity prices. A meaningful improvement in export outlook is not seen in 2015 as demand from some of Brazil’s major trade partners is likely to remain low. Though economic growth in China, the largest importer of Brazil’s goods, has stabilized, its demand for commodities is yet to see a rebound. Meanwhile, Brazil’s neighbor and third largest trade partner Argentina is in a recession and shipments to that country are likely to decline further. Subdued export demand has also dragged down industrial output in recent months.

Nevertheless, domestic demand has so far been relatively healthier as retail sales expanded at a moderate pace in October and November of 2014. Still, some of the gains were likely due to year-end sales promotions, and spending cuts by the government could limit consumer demand in 2015. To regain investor confidence, the Brazilian government has promised to reduce the fiscal deficit by controlling public spending. The government announced cuts in pension and unemployment benefits, and also reduced the subsidy on loans from a state-controlled development bank. In addition, the government has also said it could reverse some of the tax cuts to raise additional revenues.

The economic growth forecast for 2015 has been lowered to 0.4 percent, according to a survey of economists by Brazil’s central bank. Higher than expected inflation and the currency decline forced the central bank to hike interest rates in December. Inflation at the end of 2014 was close to the 6.5 percent upper end of the central bank’s target range. Further rate hikes are expected this year as the central bank remains cautious of rising inflation expectations. Rating agencies Standard & Poor’s and Moody’s have lowered their outlooks for Brazil, citing weak growth and the wide fiscal deficit.

While the Mexican economy will likely be negatively affected by lower oil prices, the decline should not be as severe as some of the other energy exporting countries. Unlike other energy producing countries, Mexico has a policy of protecting its oil revenues from large price swings through hedging. Despite the upfront costs, this policy worked in the country’s favor during the last oil price decline after the global financial crisis. Credit rating agency Moody’s believes the Mexican government has secured its budgeted revenue receipts for 2015 from oil production through hedging. Hence, despite the expected fall in oil export revenues in 2015, Moody’s has not lowered its outlook for the country.

Nevertheless, lower oil prices could lead to job losses in the country’s energy sector and delay the much awaited reforms. Like other oil producers, Mexico’s government-owned energy company is expected to reduce new investments. As a result, the oil field service companies have reportedly started cutting their workforces in the country. The Mexican government has been trying to reform the energy sector by opening up exploration and production to foreign companies. Lower prices are likely to dull the interest of foreign companies in Mexican energy assets.

At the same time, stronger U.S. consumer demand continues to lift the outlook for exports of manufactured goods from Mexico. Though exports in November declined from the previous month, the overall trend remains positive. Automobile exports from Mexico surged to a new record in 2014, according to an auto industry group, after shipments to the U.S. increased more than 20 percent in December. The Bank of Mexico continues to hold its benchmark rate at a record low, but the bank has indicated the possibility of a rate hike in 2015 should the U.S. Federal Reserve start increasing interest rates.

CHILE: FALL IN COPPER PRICES WEAKENS ECONOMIC OUTLOOK

The outlook for the Chilean economy has deteriorated as copper prices have slipped further at the start of 2015. Copper prices have declined nearly 25 percent from the beginning of last year, denting the export prospects of Chile, which is the world’s leading producer. Total mineral exports from the country during 2014 were the lowest in four years and a quick recovery is unlikely as global industrial demand remains subdued. The country’s central bank has estimated that the economy expanded 1.7 percent last year, but is more hopeful for 2015 when the bank expects growth of 2.5 percent to 3.5 percent.

An increase in government spending has supported domestic demand and has lowered the unemployment rate in recent months. Chile’s jobless rate declined to 6.1 percent in November, as the loss of jobs in the mining sector was offset by increased hiring in sectors such as healthcare and other services. The government had announced a nearly 10 percent increase in public spending for 2015, to be funded by higher taxes.

Meanwhile, the central bank continues to hold its benchmark rate steady as wage growth remains robust. Though consumer prices declined in December, the strengthening labor markets pushed up average wages by 7 percent in November, from a year ago. However, according to the survey of economists and traders conducted by the central bank, the benchmark rate is likely to be lowered further during the first half of 2015.

PERU: FISCAL AND MONETARY STIMULUS TO COUNTER WEAK EXPORT DEMAND

The Peruvian economy slowed significantly during 2014 as international commodity prices weakened and the trend is expected to continue in 2015 as well. The pace of economic expansion dropped below 3 percent for the first nine months of 2014, compared to 5.8 percent for the previous year. Output growth slowed again in October and November, according to the country’s statistics agency. The decline was primarily due to weak external demand and Peru’s trade account was in deficit for most of 2014. In addition to copper, Peru is also a leading exporter of gold, silver, lead and zinc.

To prevent further economic decline, the government announced a fiscal stimulus package and is increasing infrastructure spending this year. Reductions in corporate and personal income taxes are the major feature of a nearly $4 billion stimulus package announced in November. Weak commodity prices are forcing mining companies to delay or even cancel new capital investments. To counter this, the government has proposed to partially finance infrastructure projects in basic sectors such as transportation, education and healthcare. These new projects are estimated to have a total outlay of close to $7 billion.

In addition, the central bank announced a surprise interest rate cut and new measures to limit exchange rate volatility. After holding steady for three months, the central bank lowered its benchmark rate in January as inflation expectations have moderated. Consumer inflation was above 3 percent in December, but the central bank expects it to decline to nearly 2 percent, the midpoint of the bank’s target range. The bank has also set limits on trading in currency derivatives to limit exchange rate volatility. The Peruvian sol depreciated more than 5 percent against the U.S. dollar in 2014.

Though Colombia is one of the major oil exporters in Latin America, its government is confident that lower oil prices will not lead to a sharp decline in 2015 GDP growth. While acknowledging that the fall in oil export revenues could bring down the growth rate this year, when compared to 2014, the government believes the country’s diverse economy will limit the downside. Less than 20 percent of the government’s revenue comes from energy production and the government is prepared to run a wider budget deficit this year. The country’s economic growth is expected to moderate to 4.2 percent, from 4.7 percent estimated for 2014. If this forecast is achieved, Colombia will remain one of the fastest growing economies in the region.

The decline in oil prices and the strengthening of the U.S. dollar against other currencies have pulled down the Colombian peso in recent months, and should help exports from the country. In addition to oil, Colombia’s biggest export, the country ships farm produce, precious metals and garments to overseas markets. Stronger consumer demand in the U.S., Colombia’s largest trading partner that accounts for nearly 40 percent of all export shipments from the country, should also help improve the outlook for exports.

Colombia’s central bank kept its benchmark rate unchanged during the last quarter of 2014, citing healthy domestic demand. The relatively faster economic growth, when compared to other economies in the region, is another factor that has influenced the bank’s policy decision recently. While no interest rate changes are expected until 2016, the central bank has sufficient flexibility to ease rates if the economy decelerates more. The central bank has also ended its U.S. dollar purchases, which were started in 2012 to prevent currency appreciation as well as to build sufficient currency reserves.

ARGENTINA: ECONOMY EXPECTED TO DECLINE IN 2015

The Argentinean economy is expected to be one of the worst performers in the region in 2015, as the country continues to face several challenges. While weaker global demand and lower commodity prices have led to a fall in exports, domestic demand also remains restricted. The subdued growth outlook for Brazil, Argentina’s largest trading partner, could further weaken the outlook for exports this year. The Argentinean government could also face difficulties in refinancing some of the bonds that are due for repayment, as international investors are likely to remain cautious after the country defaulted again in 2014.

The country’s economy likely contracted in 2014 and the International Monetary Fund expects another 1.5 percent fall in 2015. GDP declined during the third quarter of 2014, and the trend is likely to have continued during the fourth quarter when external demand and commodity prices were weaker. To help support domestic demand, the government reduced retail fuel prices in December.

Argentina’s efforts to raise funds from bond issues have so far failed to attract enough investors. As the country is effectively banned from international bond markets after the most recent default, the government offered $3 billion worth of bonds under its domestic laws in December. However, it could sell only 10 percent of the total offer. Argentina has nearly $12 billion of sovereign debt maturing this year and it will be difficult for the government to refinance in the current environment.

This article is for informational purposes only. This article is not intended to provide tax, legal, insurance or other investment advice. Unless otherwise specified, you are solely responsible for determining whether any investment, security or other product or service is appropriate for you based on your personal investment objectives and financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation. The information contained in this article does not, in any way, constitute investment advice and should not be considered a recommendation to buy or sell any security discussed herein. It should not be assumed that any investment will be profitable or will equal the performance of any security mentioned herein. Thomas White International, Ltd, may, from time to time, have a position or interest in, or may buy, sell or otherwise transact in, or with respect to, a particular security, issuer or market on our own behalf or on behalf of a client account.

FORWARD LOOKING STATEMENTS

Certain statements made in this article may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. undertakes no responsibility to update publicly or revise any forward looking statements.

Q: What is the PIMCO Multi-Strategy Alternative Strategy?Worah: The strategy is an “all in one” liquid alternatives approach that seeks to generate attractive risk-adjusted returns across market environments, with a focus on limiting portfolio downside during large corrections in equity or bond markets. The majority of the portfolio is dynamically allocated across the full suite of PIMCO’s liquid alternative offerings. It also has the ability to invest directly in individual securities, which helps facilitate better risk management and allows us to access additional complementary alternative strategies.

Q: What are the potential benefits to investors?Davis: Return potential, diversification and convenience are the big ones. Through a single investment, our strategy allows investors to access the complete suite of PIMCO’s liquid alternative strategies.

In a New Neutral environment that anticipates muted returns and heightened volatility, many investors have looked to liquid alternatives in an effort to boost returns and lower overall portfolio risks. Yet the risks and returns of liquid alternative strategies tend to vary markedly between strategies, even within the same category. This creates a challenge for investors seeking to assemble and manage a diversified portfolio of liquid alternative strategies.

Our approach seeks to efficiently combine a range of complementary liquid alternative strategies, offering the potential for diversification and higher return per unit of risk than a single strategy could achieve on its own. In so doing, we address the three key challenges that investors face when allocating to liquid alternatives: strategy selection, asset allocation and risk management.

Q: What is unique about this strategy?Fahmi: PIMCO is one of the few managers with such a broad suite of independent liquid alternative strategies, and we are the largest provider of alternative mutual fund strategies in the U.S. as of December 2014, as defined by Morningstar. Portfolio managers of the underlying liquid alternative strategies include two Morningstar U.S. Fixed-Income Fund Managers of the Year award recipients, Mark Kiesel in 2012 and Alfred Murata in 2013, as well as Rob Arnott, co-Founder of Research Affiliates and a pioneer in fundamental indexing.

A key differentiating feature of this strategy is its ability to tactically allocate and manage risk. We have full look-through into the investment positions of strategies that we manage in-house, which allows us to monitor changes in risk exposures and liquidity in real time. It also allows us to make prudent allocation shifts if we find there are meaningful changes in risk exposures of underlying strategies.

Furthermore, we primarily allocate to mutual fund strategies that provide daily liquidity in contrast to approaches that offer daily liquidity but allocate to third-party managers who may offer liquidity only on a monthly, or even less frequent, basis.

Finally, our approach has the flexibility to invest in individual securities to gain exposure to additional liquid alternative strategies and to manage overall portfolio risks. This allows us to efficiently manage overall exposures – both in the component strategies and at an aggregate level – and hedge undesired ones.

Q: Could you describe the investment process?Davis: The investment process is designed to construct a portfolio that is balanced across a diversified set of strategies, optimized to achieve our investment objectives. It begins with our proprietary risk systems that look through the underlying strategies in real time to estimate key inputs in the portfolio construction process – in particular, correlations and volatilities of the underlying strategies. We then construct a target risk allocation that seeks to diversify risk across our investment opportunity set, while accounting for potential overlap in positions across some strategies. Finally, the portfolio is monitored daily to ensure allocations remain within target. Even though we already have a very broad investment opportunity set, we have the flexibility to include new strategies over time.

Mihir, Mohsen and I work closely as a team to evaluate new strategies for inclusion in the opportunity set.

Q: Could you elaborate on how investors should think about incorporating this strategy into their existing asset allocation?A: The size and placement of an allocation in a portfolio can vary based on investor objectives and constraints. For investors who have carved out an allocation to liquid alternatives, this strategy can play a central role as it provides broad exposure to multiple liquid alternative strategies and seeks attractive risk-adjusted return potential and diversification to traditional stocks and bonds. Alternatively, because many of the strategy’s underlying investments seek to deliver returns from stock and bond markets but in a less constrained manner than traditional approaches, it can also be used as a stand-alone complement to traditional stock and bond allocations.

​Past performance is not a guarantee or a reliable indicator of future results. Investing in the bondmarket is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Swaps are a type of derivative; swaps are increasingly subject to central clearing and exchange-trading. Swaps that are not centrally cleared and exchange-traded may be less liquid than exchange-traded instruments.

PIMCO’s liquid alternative strategies are without the principal lock-ups of traditional private equity funds and hedge funds and include separate accounts whose holdings can be liquidated at a client’s request subject to current market conditions, mutual funds that can be liquidated at NAV on a daily basis and ETFs that can be liquidated on the secondary market under normal market conditions. There is no guarantee that a security will be able to be liquidated in a timely fashion or when it would be most advantageous to do so.

Diversification does not ensure against loss. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

The Morningstar Fixed Income Fund Manager of the Year award is based on the strength of the manager, performance, strategy, and firm’s stewardship (2012/2013). Morningstar named Dan Ivascyn and Alfred Murata the 2013 Fixed Income Manager of the Year (US).

A key problem with diffusion indices is the size of the company does not matter. For example, a chemical company with 300 employees carries the same weight as an auto manufacturer with 200,000 employees.

Moreover, there are some peculiarities with the break-even number of 50.

The ISM says A PMI® in excess of 43.1 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the January PMI® indicates growth for the 68th consecutive month in the overall economy, and indicates expansion in the manufacturing sector for the 20th consecutive month. Holcomb stated, "The past relationship between the PMI® and the overall economy indicates that the PMI® for January (53.5 percent) corresponds to a 3.3 percent increase in real gross domestic product (GDP) on an annualized basis."

Thus, a manufacturing PMI above or below 50, does not imply similar overall economic activity as one might expect. Also, month-to-month changes show a lot a variances so it's important to look at trends over a longer period of time.

There were 10 occasions since 1950 in which the year-over-year growth of manufacturing PMI sunk to -20% that were not associated with a recession.

On the other hand, the chart shows that recessions generally start with the PMI near the zero-growth line. In those occasions where recessions started with PMIs well above 50, the PMI quickly crashed into negative territory.

Barely one month into 2015 and the ECB has finally unveiled its long-anticipated quantitative easing (QE) program, which will commence in March. Recognizing the need to act in a big way, the ECB will begin purchasing a larger than anticipated Euro 50 billion per month of bonds issued by its 19 member countries. Underscoring the perceived severity of the economic crisis facing the Euro region, this program is open-ended and will remain in effect through at least September 2016, much to the chagrin of Germany, the largest and most fiscally sound member of the European Union. Unlike the recently terminated American version of QE, ECB President Mario Draghi will likely have significantly greater challenges in executing his plan.

Reacting to the increasingly dire European economic situation, the Swiss government has elected to stop defending its currency versus the Euro, which resulted in an immediate 20% valuation surge. Meanwhile, the Euro continues to slide, currently at 1.12 versus the USD, down from 1.40 last summer. We anticipate the peg will reach close to parity later this year. While possibly a positive for European exporters, most imported commodities used in manufacturing and production are priced in USD’s. So, the weakening currency is offsetting much of the beneficial decline in oil prices. Worries about the viability of Greece, the most fragile of the ECB member countries, are intensifying following last weekend’s landslide election of the radical left Syriza party.

It appears to us that the broadening global weakness could be beginning to negatively impact the U.S. expansion. Heightened stock market volatility suggests more of a two-way trading environment, if not an outright sustained correction. This pattern will likely give investors pause, especially those who have been spoiled by the mostly one-way direction of the U.S stock market the past two years. Recent Q4 earnings announcements have been mixed and many companies continue to guide 2015 earnings as well as market expectations lower. Investor sentiment might be shifting.

Recently, both the World Bank and the IMF dropped their global growth forecasts for 2015; only the U.S. economy’s growth projection was raised. Eurozone growth is targeted at only 1.2% while unemployment remains near 12%. Japan is mired in recession and implemented its own QE bond buying program last year. Emerging market countries, led by China, continue to disappoint. Many in Latin America, such as Brazil, rely on commodity exports for a major portion of GDP. Softening global demand, intensifying supply competition (e.g., oil), and a strengthening dollar, have combined to paint a fairly disappointing picture. Developing nations are primarily dependent on world trade. Stimulus measures undertaken after the 2008 financial crisis have run their course leaving many with high debt loads.

Exports account for less than 15% of U.S. GDP, so the stronger dollar should not be too disruptive to domestic economic prospects; however, multi-national corporations, dependent on foreign earnings, will likely experience a hit to future EPS. Inflation should remain low even as increased consumer spending on a multitude of less expensive imported goods will aid the domestic economy. Cheap energy costs is shifting spending patterns. The employment picture continues to improve as evidenced by the latest 5.6% unemployment reading.

Given the current state of global events, we see no reason for the Fed to prematurely move ahead with its rate normalization plan as many anticipate occurring by mid-year 2015. The employment picture continues to improve and inflation continues to run well-below the Fed’s 2% target. Therefore, rates will stay lower for longer - perhaps into 2016.

Despite investment yields falling further in January, U.S. government bonds are even more attractive today on a comparative basis. At a yield of 1.80% currently, the UST 10-year note yields 30 bp more than UK Gilt, 140 bp over German Bund, and 160 bp better than Japanese debt. Foreign buyers of U.S. obligations also gain from renewed USD strength.

Bond yields have the potential to move even lower from here and we are positioning client portfolios to take advantage of the still constructive environment. The more volatile trading environment in virtually all financial markets is not surprising after the prolonged period of tranquility exhibited last year. The whipsaw trading patterns in stocks and Treasuries has been evident in the tax-exempt arena as well. The graph below depicts the shift of the municipal yield curve in January. While yields have dropped across all maturities, the greatest effect was registered in the short and long term maturity ranges. Intermediate maturities (10 to 20 years) have not participated to the same degree, thereby registering less yield decline. The resulting “steepening” of the curve in the intermediate range renders it the most attractive for investment.

The strong responsiveness by Treasury yields to the aforementioned factors has left municipals trailing in the race to lower rates. 10-year “AAA-rated” municipals currently yield more than 100% of similar maturity Treasuries. The relative attractiveness should attract buying interest from additional non-traditional tax-exempt buyers.

Shift in the Municipal Yield Curve From Year-End 2014

Source: Bloomberg

The municipal market will continue to take its direction from Treasuries. Favorable market technical conditions are in place for sustaining lower rates. Investor demand has been very robust since the start of the year, which has translated into strong money flows into tax-exempt mutual funds, including nearly $1 billion just last week, nearly twice the weekly average of 2014 according to the Investment Company Institute. Also, there is significant amount of outstanding securities maturing through February. Market reduction continues: last year the $3.5 trillion municipal market contracted by 4% and further shrinkage is expected this year.

Following the State of the Union speech last week, there has been renewed discussions in Washington about solutions to address the critical need for infrastructure spending throughout the country. The President called for legislation to create public/private partnerships. Near-term, we think the prospect for a bipartisan agreement is remote. While the financial state-of-the-states is much improved, fiscal discipline is still the primary focus in most state capitals. Mounting pension and health care costs, combined with new requirements for more conservative actuarial earnings assumptions precludes much in the way of capital spending initiatives. Municipal borrowers should at least be encouraged by the outlook for sustained lower borrowing costs for a longer period of time.

smcfixedincome.com

Disclosures

The information provided in this commentary is not intended to be a complete summary of all available data. Certain information contained herein has been obtained from published sources and/or prepared by sources outside SMC Fixed Income Management (“SMC FIM”), a division of Spring Mountain Capital, LP, and certain information contained herein may not be updated through the date hereof. While such sources are believed to be reliable, no representations are made as to the accuracy or completeness thereof by SMC FIM or any of its affiliates, directors, officers, employees, partners, members or shareholders, and none of the former assumes any responsibility for the accuracy or completeness of such information. Nothing contained herein shall be relied upon as a promise or representation as to past or future performance.

This commentary is neither an offer to sell nor a solicitation of an offer to purchase securities, any other investments or any other product sponsored or advised by SMCFIM, nor does it constitute an offer or a solicitation to otherwise provide investment advisory services. Such an offer or solicitation may be made only by the relevant documents for the relevant investment vehicle and/or investment program. This commentary is not, and may not be used as, a recommendation of any security, investment program or vehicle. There is no assurance that any securities discussed herein will remain in a client’s account at the time you receive this commentary or that securities sold have not been repurchased. The securities discussed do not represent the client’s entire portfolio and in the aggregate may represent only a small percentage of the client’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

Statements contained in this commentary that are not historic facts are based on current expectations, estimates, projections, opinions and beliefs of SMC FIM. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. Unless specified, any views reflected herein are those of SMC FIM and are subject to change without notice. SMC FIM is not under any obligation to update or keep current the information contained herein.

This commentary does not take into account any particular investor’s investment objectives or tolerance for risk. The information contained in this commentary is presented solely with respect to the date of its preparation, or as of such earlier date specified in it, and may be changed or updated at any time without notice to any of the recipients of it (whether or not some other recipients receive changes or updates to the information in it).

No assurances can be made that any aims, assumptions, expectations, and/or objectives described in this commentary will be realized. None of SMC FIM or any of its affiliates, directors, officers, employees, partners, members or shareholders shall be liable for any errors in the information, beliefs, and/or opinions included in this commentary or for the consequences of relying on such information, beliefs, or opinions.

Neither this commentary, nor any of the contents hereof, may be reproduced or used for any other purpose, or transmitted or disclosed in whole or in part to any third parties, in each case without the prior written consent of SMC FIM.

The combination of widening credit spreads, deteriorating market internals, plunging commodity prices, and collapsing yields on Treasury debt continues to be most consistent with an abrupt slowing in global economic activity. Generally speaking, joint market action like this provides the earliest signal of potential economic strains, followed by the new orders and production components of regional purchasing managers indices and Fed surveys, followed by real sales, followed by real production, followed by real income, followed by new claims for unemployment, and confirmed much later by payroll employment. Stronger conclusions, particularly about the U.S. economy, will require more evidence, but from a global perspective, these pressures are already quite evident.

It’s striking how little economic thought seems to go into talking-head assessments of these developments. The plunge in Treasury yields, for example, is attributed to yield-seeking in response to expectations of European Q-ECB. But if investors still retained speculative yield-seeking preferences, we would observe that uniformly through similar yield-seeking in lower quality credit, as well as risk-seeking in equities without large internal divergences (factors that serve as the central distinction between overvalued markets that continue to advance, and overvalued markets that drop like a rock – see A Most Important Distinction). Instead, the broad retreat – though still early – from speculative assets toward havens considered free of default, essentially signals a shift toward risk aversion. Bad things tend to happen when compressed risk premiums meet increasing risk aversion. As I’ve frequently noted, risk premiums tend to normalize in spikes, so low and expanding risk premiums are the root of abrupt market losses.

While Wall Street talking heads seem unanimous in viewing the decline in oil prices as “stimulative” for the global economy, on the notion that it frees up spending money for other purposes, the problem is that the decline in oil prices is indicative of a retreat in global demand. That is, when prices fall, it makes a difference whether the decline is due to an expansion of supply (which lowers price but expands output), or a retreat in demand (which also lowers price but contracts output). If the demand curve shifts back, you don’t take the lower price that resulted from the reduction of demand, and then use it as an argument that demand is going to increase (and then use that as an argument that increased demand will raise the price, and then…) No. The decline in price is itself an equilibrium outcome of the decline in demand. At that point, you end the sentence.

Unfortunately for monetary authorities around the world, the same is true for interest rates here. Attempts to press interest rates to preposterously low levels aren’t stimulating demand for borrowing, because the global economy is already submerged in its own indebtedness. Yes, before investor preferences shifted toward risk aversion in about mid-2014, depressed yields on safer investment classes did create an opportunity for really junky issuers to issue debt to yield-seeking investors by offering a “pickup” above Treasury yields. We saw the same thing during the housing bubble, which allowed an enormous amount of malinvestment funded by yield-seeking. In the recent cycle, the malinvestment has primarily taken the form of leveraged loans (loans to already highly-indebted borrowers), and “covenant-lite” junk lending. The other primary form of malinvestment has been through corporate repurchases of equities that are strenuously overvalued on historically reliable measures, financed – make no mistake – through the issuance of new debt (see The Two Pillars of Full Cycle Investing for the data on this).

So what we’ve really got is a situation where interest rates are low because safer borrowers are swimming in debt, while credit spreads are widening because junkier borrowers are hugely sensitive to even a moderate slowing in global economic activity.

We generally agree with Charles Plosser, one of the more economically thoughtful minds at the Federal Reserve, who observed last week:

“The history is that monetary policy is not ultimately a very effective tool at solving real economic structural problems. It can try for a while but the problem then is that it’s only temporarily effective, and when you can’t do it anymore you get the explosion yesterday in the Swiss market. One of the things I’ve tried to argue is look, if we believe that monetary policy is doing what we say it’s doing and depressing real interest rates and goosing the economy, and we’re in some sense distorting what might be the normal market outcomes, at some point we’re going to have to stop doing it. At some point the pressure is going to be too great. The market forces are going to overwhelm us. We’re not going to be able to hold the line anymore. And then you get that rapid snapback in premiums as the market realizes that central banks can’t do this forever. And that’s going to cause volatility and disruption.”

That’s already an issue at present. If we were still in an environment where investors were risk-seeking (which we infer from the uniformity of market internals, credit spreads, and other risk-sensitive market action), overvalued markets might have a tendency to become more overvalued, regardless of how thin risk premiums might be. That, right there, is the essential lesson to be drawn from our own challenges in the recent half-cycle, at least until about June of last year when we viewed them as fully addressed (see A Better Lesson Than “This Time is Different” – probably the best reference on that awkward transition). But once internals and credit spreads deteriorate, as they have been doing in recent months, compressed risk-premiums have a tendency to normalize - not gently, but in spikes, which we observe in price action as air-pockets, free-falls, and crashes.

Where I think Plosser and I might disagree is that, in my view, the first step by the Federal Reserve should not be to raise interest rates – indeed, in the face of what we view as a clear deterioration in global economic prospects, I question that this would be particularly constructive – and would cast a great deal of blame toward the Fed if the weakness continues. Not to say that raising rates would have much actual effect on economic activity, as the only form of economic activity that has proved responsive to zero-interest rate policy are those activities where interest itself is the primary cost of doing business: financial speculation and leveraged carry trades. But hiking rates by paying interest on reserves, rather than by normalizing the monetary base, would have no promising effects. In my view, the primary response to a hike in the Fed Funds rate (achieved by raising the interest rate paid on reserves) would be to draw currency out of circulation and expand the already grotesque mountain of idle reserves in the banking system.

Rather, I think the Fed should – and should immediately – cease the reinvestment of principal as assets on the Fed’s balance sheet mature. There’s utterly no sense to these reinvestments, as 1) the balance sheet could contract by about $1.4 trillion without moving short-term interest rates from zero (see A Sensible Proposal and a New Adjective), and 2) at the present 10-year Treasury yield of 1.64% and interest on reserves of 0.25%, the breakeven curve on new bond purchases by the Fed – the future yields that would result in zero total returns, even after interest income – are just 1.81% on a 1-year horizon, 2.02% on a 2-year horizon, and 2.29% on a 3-year horizon. Future yields any higher than that will produce net losses to the Fed.

Now, my impression is that yields may move even lower over the next few quarters if the economy weakens, in which case we might even see a 1-handle on the 30-year bond and a 0-handle on the 10-year. But bonds are already priced at speculative levels in the sense that one must expect virtually no normalization of yields at all, for years to come, if one is to avoid net losses on purchases at these levels. As usual, our own approach leans toward seeking longer duration on upward spikes in yields, and avoiding long-duration exposures on overextended retreats in yield. In short, 10-year Treasury bonds are priced to be feeble long-term investments, as are nearly all other investment classes thanks to years of yield-seeking speculation. But the assets that will be hit first – and hit hardest in any normalization of yields or risk premiums – are likely to be junk, then equities, then seemingly credit-worthy corporates, with Treasury debt at the tail end of that normalization.

But – a Fed-chasing lemming might counter, in the belief that Federal Reserve intervention “works” regardless of investor risk preferences – if the economy softens, doesn’t that ensure that the Fed will come to the rescue by deferring any hike in interest rates? Won’t that in turn drive the financial markets higher?

There are two answers to that question. The first, as I noted in The Line Between Rational Speculation and Market Collapse, is a reminder that the Fed did not tighten in 1929, but instead began cutting interest rates on February 11, 1930 – nearly two and a half years before the market bottomed. The Fed cut rates on January 3, 2001 just as a two-year bear market collapse was starting, and kept cutting all the way down. The Fed cut the federal funds rate on September 18, 2007 – several weeks before the top of the market, and kept cutting all the way down.

As a result, the second answer to the question above is that it is the wrong question. Our attention should not be absorbed in speculation about what the Fed might or might not do, but should instead attend to measures of investor risk preferences such as market internals and credit spreads. In the event they improve – which we certainly don’t rule out but don’t particularly expect in the near term either – the immediacy of our concerns about downside risk will ease markedly. Depending on the status of other market conditions, we may even observe an opportunity to encourage an outlook more along the lines of “constructive with a safety net.” On the other hand, if we observe a material retreat in valuations followed by an improvement in market action, I expect we could encourage a clearly constructive or even aggressive stance toward the market. So we’ll take our evidence as it comes, with a continued focus on adhering to a historically informed, value-conscious, risk-managed discipline.

With respect to risk management, it’s helpful to recognize that it takes two back-to-back 33% losses to experience a 55% loss as the S&P 500 did in 2007-2009. Compounding has very interesting effects over the course of a market cycle. A 50% loss wipes out a 100% gain. A 20% gain in asset X during a 40% loss in asset Y leaves asset X at double the value of asset Y. Passive investment strategies invariably look desirable relative to risk-managed strategies at the peak of a market cycle, because risk-management looks like a mistake in hindsight. Over the course of the complete market cycle – of which we have now experienced an unfinished half – those relative comparisons typically look dramatically different.

With median valuations for the average stock higher now than in 2000 on the basis of price/revenue, price/earnings, and enterprise-value to EBITDA; with numerous historically reliable valuation measures more than double their pre-bubble historical norms; and with the S&P 500 now beyond the peak valuations of every market cycle on record (including 1929) except for the final quarters surrounding the 2000 bubble, understand that stocks are no longer an investment but a speculation. There are times that such speculation tends to work out – but those times require risk-seeking preferences among investors, which can be inferred from features of market action that are not in place at present. I expect that these distinctions will serve us greatly over the completion of the present cycle and in those to come.

As for the completion of the present cycle, I’ll say this again – the 2000-2002 decline wiped out the entire total return of the S&P 500, in excess of Treasury bill returns – all the way back to May 1996. The 2007-2009 decline wiped out the entire total return of the S&P 500, in excess of Treasury bills – all the way back to June 1995. A shift back toward risk-seeking preferences among investors will not relieve the extreme overvaluation of the equity market, but it would defer our immediate concerns. We may observe constructive opportunities along the way, but we view it as inescapable that the completion of the current market cycle will end in tears for investors who don’t carefully align their investment exposures with their expected spending horizon (see the second half of Hard Won Lessons and the Bird in the Hand for a discussion of these considerations). For now, we maintain a sharply negative outlook toward equities.

Past performance does not ensure future results, and there is no assurance that the Hussman Funds will achieve their investment objectives. An investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance quoted above. More current performance data through the most recent month-end is available at www.hussmanfunds.com. Investors should consider the investment objectives, risks, and charges and expenses of the Funds carefully before investing. For this and other information, please obtain a Prospectus and read it carefully.

Last week the Trade Followers social media indicators for the S&P 500 Index (SPX) suggested that the market wasn’t out of the woods yet due to several factors. Chief among them was a warning from our sector sentiment readings. They indicated that market participants were rotating to safety as the market rallied. Every time all sectors were positive since we’ve been tracking them has resulted in a short term top within two weeks. On this occurrence the top came the next day. This past week sector sentiment was decidedly bearish with large negative readings from basic materials, industrials, and technology, while the defensive sectors had moderately positive prints. Leading sectors were being sold and defensive sectors were still being bought.

Twitter and StockTwits breadth indicators are falling, but it isn’t due to a lack of strong stocks. In fact, last week saw a slight increase in the number of stocks on the bullish list even though the market fell. The weakness comes from a fairly large increase in the number of bearish stocks. The underlying numbers paint a picture of investors getting much more selective. At the same time they’re more willing to sell on any bad news.

Momentum indicators generated from Twitter and StockTwits for the S&P 500 Index (SPX) weren’t damaged much by last week’s decline in price. However, they weren’t inspired by the rally the week before either. That leaves them with tepid readings that are indicative of traders sitting on their hands and waiting.

Another sign traders are waiting comes from support and resistance levels gleaned from the Twitter stream. The vast majority of tweets last week projected price inside the recent range between 1990 and 2065. Even though we’re sitting near the low end of the range there aren’t a lot of tweets for lower prices. This makes the current range extremely important. If the current range breaks lower, support comes at 1975, 1955, and 1910 on SPX. Current resistance is 2000, 2020, and 2065.

Bottom line, market participants are waiting for a break of the current range, but getting defensive while they wait. Defensive sectors are still being bought, the bearish stock list is growing, momentum is tepid, and price targets from traders are mostly in the current price range. That leaves us waiting to see how our indicators react to a break of the range.

If the market breaks lower watch the bullish lists to see if the leaders are being toppled as an indication of a probable correction. Watch the bearish lists and momentum if the market rallies back to the top of the range. We want to see some risk taking (stocks falling off the bearish lists) and enthusiasm for higher prices from momentum.

Blair Jensen is president of Trade Followers. The Trade Followers algorithm quantifies social media and creates stock market indicators that track the momentum of the crowd on Twitter and StockTwits.

This is a landslide week for economic data, and earnings season is in full swing. Last week’s Q4 GDP report and overall market tone has revived deflation concerns. I expect market participants to be watching each economic release closely, asking: Are there signs of incipient economic weakness?

Prior Theme Recap

In last week’s WTWA I predicted that there would be special attention to Europe and the Greek elections, with a mid-week switch to the Fed and continuing interest in earnings. That was pretty accurate for the week as a whole, but there were two surprises. The downbeat GDP report, normally regarded as old news that will be further revised, had a modest pre-market and intra-day effect. The late-day ISIS/Iraq news was important on Friday afternoon. Since the spike in energy prices had a specific cause and left many not wanting to be short over the weekend, the standard energy-stock price correlation did not hold up. This was just bad news.

There is no better way to review the past week than Doug Short’s 15-minute chart. While I highlight this time period for the “week behind” purpose, Doug’s article has plenty of other charts and great analysis. I hope readers are following the links.

Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.

This Week’s Theme

The week ahead includes plenty of economic news, earnings reports, speechifying, and geopolitics. People frequently expect this to mean exceptional volatility, and it might. More often the news cuts both ways. As we saw last week, volatility can result from a few key stories, especially when the news is a surprise.

The disappointing report on Q4 GDP has set the tone for this week. The popular meme has been that declining commodity prices and bond yields carry an important message about the US economy. I expect a major media focus to be the following:

Do the economic data reveal growing weakness in the US economy?

I expect this to be sliced, diced, and compared to the “messages” from commodity prices and corporate earnings, continuing through Friday’s employment report. Here are the contending viewpoints:

QE is failing everywhere. Central bankers are out of ammo. Marc Faber in this week’s Barron’s roundtable wants to “short central bankers.” Also writing for Barron’s, Vito J. Racanelli captures what I often call the trader perspective:

Ostensibly, investors were disappointed by data on U.S. economic growth, but the deeper issue is a nascent feeling that the worldwide quantitative easing (QE) cycle has reached the limits of encouraging growth.

This thinking is sustained by tumbling oil prices—which rose 6% last week to $48.24 per barrel but have fallen for seven consecutive months. Where once that plunge was welcome, investors now see it as a barometer of weak global gross-domestic-product (GDP) growth in 2014. The ongoing Greek drama over the country’s huge fiscal imbalances is also fueling uncertainty and keeping pressure on stock prices.

Global economic signs are showing some bottoming. Dr. Ed considers Asian countries, commodities, monetary policy and the Year of the Sheep.

My sense is that choice #1 is the prevailing theme. What do you think?

As always, I have some additional ideas in today’s conclusion. But first, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially – no politics.

It is better than expectations.

The Good

Despite the market reaction, there was plenty of good news last week.

Weekly jobless claims fell dramatically, to 265K, lowest since 2000. The survey period included the MLK holiday, but the BLS did not cite that as a problem. Normally I would not mention this, preferring to look at the four-week average of the noisy series, but I have highlighted as “bad news” the two recent reports above 300K. It is only fair to mention the good news. Properly interpreted, this is an important series.

Earnings reports have been positive. It does not seem like it, but 80% of reporting S&P companies have beaten on earnings and 58% on sales. Overall growth is running at 2.1%, slightly better than predicted at the start of the quarter. Apple was a big positive for the overall numbers and energy stocks remain a drag (FactSet).

Personal consumption increased 4.3%, beating expectations of 4%.

Michigan consumer confidence nearly held the preliminary reading, scoring 98.1. Some ascribe the enthusiasm to lower gas prices or the hiring of Jim Harbaugh as the new football coach. In fact, this is an excellent nationwide survey which takes a panel approach. This means that there are some continuing members each month. My own research shows it to be helpful in tracking both spending and employment. Regular readers know that I love the Doug Short chart, which clearly illustrates the economic relationships. As always, his posts have plenty of extra analysis and charts, so please check it out.

The Bad

The bad news included some significant economic reports.

Greek elections. To emphasize, I am not interested in the politics nor am I advocating particular policies. There is a simple test: Is this market-friendly news. The Syriza success increased uncertainty for the Eurozone. When the new coalition took a hard line about austerity and negotiating with “the troika” it opened the door to speculation about broader effects. (FT).

China’s PMI fell to 49.8, worse than the expected 50.2. This was the “official” version instead of the “flash” version. It was the “factory” PMI, not the “manufacturing” PMI. There are different data points and series for each. Make of it what you will. Someone needs to sort these out and provide some better guidance on interpretation. (Reuters).

Ukraine fighting. Violence increased during the week. While popular with the public, Putin is coming under some pressure from wealthy friends. (Bloomberg) This might eventually be a positive if it sparks a move toward compromise, but so far it has just increased reciprocal sanctions. Russia credit downgrade (WSJ). Excellent analysis from Thomas Friedman – both motivations and what might happen. Could Russia use HFT to crash the markets? (MarketWatch).

The Fed Announcement. For experienced Fed watchers focused on economic data, this seemed like a non-event. Why did stocks decline and bonds rally? You need to read this interesting interpretation from Brian Kelly, one of the Fast Money gang, to get the trader take. It seems to warn us that many are ready to react to a small change in timing of the first 25 bps increase in short-term rates. (Contra – WSJ). Bespoke sees no change, providing this analysis and chart:

Durable goods declined by 3.4%, significantly worse than expectations. Steven Hansen at GEI has full analysis and this chart:

Pending home sales fell by 3.7%, month-over month.

Q4 GDP missed expectations, growing at a 2.6% rate instead of forecasts of 3% or higher. The general media reaction emphasized reduced business investment and international concerns (WSJ). Calculated Risk says to “R-E-L-A-X” and notes the increase in consumer spending and private fixed investment. James Hamilton at Econbrowser calls the report “solid” and updates his recession indicator (1.6%). The market reaction was slightly negative, and the story has markets on edge concerning upcoming data, so I am scoring this miss as “bad news.”

The Ugly

ISIS. We always have compassion for the human effects of conflict. We must also recognize the economic effects. The spread of fighting to Kirkuk shows how sensitive oil markets are to supply disruptions. Futures spiked 8% in a few minutes. Stocks sold off sharply.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger. No award this week, but nominations are welcome. I am seeing plenty of bad charts, but little refutation.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. While we feature the recession analysis, Dwaine also has a number of interesting market indicators.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug has the latest interviews as well as discussion. Also see Doug’s Big Four summary of key indicators.

Despite the facts, the average fund manager or trader views oil prices as a recession signal. (MarketWatch)

Dana Lyons notes, without really recommending this indicator, notes that the Baltic Dry Index is at a 30-year low. I dumped this indicator years ago when it seemed to reflect supply from Greek shipping magnates more than actual shipping and demand. Perhaps aluminum is better. (WSJ).

This is a subject where many authors begin with a viewpoint….

The Week Ahead

It is a big week for economic data.

The “A List” includes the following:

Employment report (F). Despite the revisions and large error band, this remains the focus of the economic debate.

Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.

ISM Index (M). Good concurrent read on manufacturing with some leading components.

Personal income and spending (M). December data, but especially important given last week’s GDP news.

The “B List” includes the following:

ISM services index (M). Bigger sector than manufacturing, but still not as much significance.

Trade balance (Th). December numbers will affect Q4 GDP revisions.

Auto sales (T). Good read on consumers. Will the F150 indicator start to be relevant again?

Crude oil inventories (W). Maintains recent interest and importance.

Productivity and unit labor costs (Th). Indicator of the pressure (or lack thereof) on the Fed’s patience in raising rates.

PCE prices (M). The Fed’s favorite inflation measure will become more important when the core approaches 2.5%

Construction spending (M). December data makes it a bit less relevant, but still significant.

With the FOMC announcement out of the way, your favorite Fed speaker is back on the speech circuit!

Important corporate earnings continue. There is always the chance of breaking news from various hot spots, but this week seems to have more such potential than usual.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix continues a “neutral” posture for the three-week market forecast, but it continues to be a close call. The data have improved a bit, but are still marginally neutral. There is still plenty of uncertainty reflected by the high (but declining) percentage of sectors in the penalty box. Our current position is still fully invested in three leading sectors, but these still include some defensive themes. This helped us dodge most of last week’s decline. For more information, I have posted a further description — Meet Felix and Oscar. You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Another 8-Step guide for traders, this time from Steve Burns. Some advice will be familiar. I like “Hold your opinions loosely and your discipline tightly.”

As I have noted for four weeks, Felix continues to feature selected energy holdings. Felix is not just a momentum trader!

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. Major market declines occur after business cycle peaks, sparked by severely declining earnings. Our methods are focused on limiting this risk. We have recently updated our current ideas for investors.

Other Advice

Here is our collection of great investor advice for this week:

Getting the Right Take on QE

Former Dallas Fed President, whom I admire from his writing and appearances, and like from our personal conversations, does not get enough credit. He is a pragmatic conservative and not a knee-jerk defender of the Fed. Anyone who really wants to understand the inner operations at the Fed would do well to read McTeer.

The fact is that the Fed’s QE programs didn’t work as expected, and it took huge bond purchases to achieve modest to moderate results. Like the rider of a very low-geared bicycle, the Fed had to peddle furiously to keep the bike upright. But, at least, the expected harm was not done and some good was done.

When short-term interest rates reached effective zero and we found ourselves in a Keynesian liquidity trap where more money would not reduce interest rates farther, there was every reason to believe that significant bond purchases would stimulate the economy by increasing the “quantity” of money and credit. We learned in school, and from past experience, that asset purchases by the central bank would increase bank reserves and the money supply initially by the same amount and that the excess reserves created in the banking system would result in a further multiple expansion in the retail money supply. Banks would use their new reserves to create new money by lending their newly created excess reserves. With about a 10 percent reserve requirement, the money multiplier would be around 10.That didn’t happen.

You could also check out my article collection on this topic, which has been quite accurate, beating down the nay-sayers since 2010.

Stock Ideas

Barron’s has the last segment of their annual roundtable. You can see plenty of divergent opinion for a small investment. I enjoy reading it with some for entertainment and others for ideas.

Beware of the reach for yield – the crowded trade that worked last year. Well it also worked in January, making me wrong so far in 2015!

Cheap Sectors

Energy and Consumer discretionary, via Alpha Architect. This is consistent with many other value sources, despite the current market love affair with utilities and bonds.

Caution in energy? That seems to be the standard take. Here is the CNBC advice, which is OK both for initiating and adding to positions.

Market Outlook

Financial media follows the theme of the moment. It was the week for the bears, back in vogue according to CNNMoney.

The bears build their case that a crisis is near on four factors: falling oil prices, stagnant wages, the “two-edged sword” of a strong US dollar and big trouble abroad.

Failure to understand the normal market drawdowns, which have actually been quite mild over the last few years. Doug Short has a great chart:

The modest downward blips send investors on a quest to become traders. They enter a world of charts, indicators, stop loss rules, and frequent adjustments. There are many successful traders, but the odds are challenging. It requires system, discipline, and constant attention – and that is just for starters. Michael Batnick has a good post for both traders and investors, and the right perspective for each. Should you be selling stocks now?

An investment perspective is much better for most. Sticking with fundamental factors, you accept the trading gyrations as opportunities to buy or to sell businesses based upon your own underlying valuations and price targets. If you have some stocks you are watching, you get exceptional buying opportunities when short-term traders are fearful. My new “Investor Fear” page takes a look at the list of oft-repeated concerns.

There are no shortcuts to successful investing.

Unless you have some magic formula. Which team are investors supposed to be cheering for in the Super Bowl?

TOKYO – Financial markets have greeted the election of Greece’s new far-left government in predictable fashion. But, though the Syriza party’s victory sent Greek equities and bonds plummeting, there is little sign of contagion to other distressed countries on the eurozone periphery. Spanish ten-year bonds, for example, are still trading at interest rates below US Treasuries. The question is how long this relative calm will prevail.

Greece’s fire-breathing new government, it is generally assumed, will have little choice but to stick to its predecessor’s program of structural reform, perhaps in return for a modest relaxation of fiscal austerity. Nonetheless, the political, social, and economic dimensions of Syriza’s victory are too significant to be ignored. Indeed, it is impossible to rule out completely a hard Greek exit from the euro (“Grexit”), much less capital controls that effectively make a euro inside Greece worth less elsewhere.

Some eurozone policymakers seem to be confident that a Greek exit from the euro, hard or soft, will no longer pose a threat to the other periphery countries. They might be right; then again, back in 2008, US policymakers thought that the collapse of one investment house, Bear Stearns, had prepared markets for the bankruptcy of another, Lehman Brothers. We know how that turned out.

What is the annual average rate of return for the market? 10.00%? 12.50%? 15.00%? This is one of those "facts" that investors hear from friends, the media and the investment industry, and it is usually wrong.

Would you believe it is less than 6% per year? Sorry to break the bad news, but the stock market’s historical data confirms it.

You are probably thinking: "This can't be true! Recent history has been much higher than 6%! The past 5 years have been great." Unfortunately, the past 5 years have been more of an anomaly than a trend.

The purpose of this report is to give consistent returns as their objective.

investors an understanding of historical returns and set proper expectations. Many money mangers have Knowing the history and volatility of returns, this is a difficult objective, but one that serves investors well.

Math Warning! I love this next part, but it is actually kind of boring.

Here’s how average annual rates of return happen: If one year has a return of 5% and the next year has a return of 10%, the average annual rate of return between the 2 years is 7.50%. (10 + 5 = 15; 15 divided by the 2 years is 7.50) When looking at data, the more information used, the more accurate the results. So if we were to look at just 2 years, or 5 years, or even 20 years, it isn’t enough data. Since market cycles can last decades, data that stretches over many decades gives a clearer, more accurate picture. The data set we used is from 1871 through 2014, 143 years.

Whether investors realize it or not, they are investing in some way or another their entire lives. They may be in the stock market, bond market, banks or any number of a myriad of other choices. Since few investors invest for only 1 year at a time, looking at how the market performed over a 5 year period is appropriate. A 5 year period is long enough to give information on the cycles and trends of the market.

It is important to understand that when we are talking about the average annual rate of return (RoR) over 5 years, we are looking at the rates of returns for those years strung together. In other words, how many times was the market able to string together 5 years that had an average annual RoR of 10% or 7% or 12.50%?

If the average annual RoR was 10% for 5 years, that does not necessarily mean that each year in the 5 year period was up 10% each year. It could have looked like this:

Year 1

8.00%

Year 2

2.00%

Year 3

17.00%

Year 4

8.00%

Year 5

15.00%

The average of these years is 10.00%. But if you start measuring the 5 years at year 2 and add another year in, it might look like this:

Year 2

2.00%

Year 3

17.00%

Year 4

8.00%

Year 5

15.00%

Year 6

-5.00%

The average annual of these 5 years drops to 7.40%. Comparing this set of 5 years to the previous set shows what is referred to as a “Rolling Period” In other words, what happens as time rolls forward. This is how investors need to view markets, in terms of rolling performance, not static. Investopedia explains that Rolling Returns is “useful for examining the behavior of returns similar to those actually experienced by investors.”

Many times, when analyzing annual RoR, calendar year returns are used. In a 10 year period, 10 data points are used. But investors do not only invest on January 1st of each year. They invest throughout the year. So in our analysis, we looked at monthly data. So in a 10 year period, we had 120 points of data instead of only 10, increasing the accuracy of our results by a factor of 12. Since we used monthly data for a 143 year time period, we used 1,716 data points.

So when looking at 5 year periods, we looked at November 1889 to November 1894, April 1993 to April 1998, Feb 2001 to Feb 2006, and everything in between. It showed that 5 year returns were volatile. The highest 5 year return was over 235% and the worst was a loss of over 70.00%.

The chart above shows our study’s results. Remember, these are 5 year returns, not annual returns. So when you see any point on the chart, that is what the market did for the 5 years, up to that point.

The chart shows there were 4 huge spikes up, over 200%. They were almost immediately followed by 5 year returns that were much lower, many times going negative.

The red line shows the average 5 year RoR. It is only 32.06%, which translates to an annualized RoR of just 5.71%. (5.71% is the compounded average annual rate of return. Dividing 32.06% by 5 will not equal 5.71% If you have any questions on compound rate of return please contact us.)

This is the historical annualized RoR of the market: 5.71%. Not exactly the double digit returns of recent years.

The chart shows that the current trend of 5 year returns has been rising, and may have peaked. If history is any guide, the next several years could see lower 5 year returns. How do we know this? First, the cycle tells us, but then there is this:

The chart below shows the frequency of the Average Annual Rates of Return over 5 years since 1871. In other words, how often was the market able to string together a certain range of annual returns over a 5 year period (Remember: When looking at 5 year periods, we looked at November 1889 to November 1894, April 1993 to April 1998, Feb 2001 to Feb 2006, and everything in between.)

It is important to remember that these are annual returns that are strung together over 5 years. In any given year, the market can have a RoR of 5%, 10%, 20%, but this chart is NOT measuring single years. It is measuring the average annual RoR over 5 years. So it is showing how consistently the market has been able to give certain ranges of returns.

The numbers along the bottom are the ranges of returns. The numbers at the tops of the columns are the percentage of time the market was able to produce that range of returns. (the frequency of the RoR) So if you look at the 2.00% to 5.00% range along the bottom and follow the column up, you see the number 14.09%. That means that the market had an average annual RoR of between 2.00% and 5.00% 14.09% of the time over a 5 year period. Some key points from the chart:

● 20.86% of the time the market returned between 5.00% and 10.00% - this was the return that occurred most often.

● 16.19% of the time the market returned between 10.00% and 15.00%

● 9.00% of the time the market returned over 15% annually over 5 years.

● 31.48% of the time, the market had a negative annual ROR, over three time the percentage of time it returned over 15%

● 43.34% of the time the Average annual return over 5 years was between 0.00% and 10.00%

Somebody that chooses an Index fund over active money management exposes themselves to these risks. Not something the Index fund companies talk about.

Looking out ten years doesn’t improve the picture.

When looking at a 10 year time frame, it becomes harder to string together a long streak of winning years.

Again, the ranges of returns are along the bottom of the chart and the frequency of those returns are at the top of each column. Here’s some key points from the 10 year chart:

● Annual Returns over 15% drop to only 1.99% of the time. It is much

● Returns between 10.00% and 15.00% happened only 17.85% of the time.

● Average Annual Returns between 0.00% and 10.00% happened 59.58% of the time.

● Negative returns over 10 years happened only 20.58% of the time.

The two ranges that happened the most often were the 2.00% to 5.00% and the 5.00% to 10.00% ranges. This makes sense since the average annual return was 5.71%. On the plus side, it was harder to lose money over 10 years. The market was down a little over 20% of the time over a 10 year period.

Why did we choose to focus on a 5 year term? It has been 5 years since the market bottomed in 2009. The resulting rally has been substantial. But is it the norm? Was the rally a new bull market, or a bear market rally? We will get into these questions in later reports.

However, investors should be long term oriented. They should be investing with that in mind. 1 year returns, even 5 year returns may be irrelevant to the long term performance of a portfolio. As the chart above shows, the current period is well above the historic average RoR. So what does this mean for an investor?

Investors that choose a passive approach, especially through index funds could be very badly disappointed by their long term performance. History and cycles tend to repeat themselves. So if the market has gone through a period of extraordinary gains, an index investor should expect to see a prolonged period of poor returns.

This is why we believe investors need to employ an active management strategy for their portfolios. The purpose of Cornerstone's active risk management is to smooth out the volatility. We employ a tactical strategy to be able to participate in the upside but give downside protection. The long term objective is to outperform over the full cycle, both the up cycle and the down cycle together.

Methodology Used: All data is from Shiller. http://www.econ.yale.edu/~shiller/data.htm Instead of using only annual data, we used monthly data to increase the accuracy by a factor of 12. The data dates back to 1871.

Opinions, estimates, forecasts and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results.

Consult your financial professional before making any investment decision. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your financial advisor for further information. These are the views of Cornerstone Investment Services LLC, and not necessarily those of the named representative, Broker dealer or Investment Advisor, and should not be construed as investment advice. Neither the named representative nor the named Broker dealer or Investment Advisor gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your financial advisor for further information.

Looking past the large upward revision to November 2014 nonfarm payrolls, you might have noticed that the U.S. economy has entered, in the words of the Federal Reserve’s version of Chance, the Gardener, Alan Greenspan, a “soft patch”. In recent months, labor conditions have weakened, manufacturing activity has hit a wall, consumer spending has waned and residential real estate demand has sunk. This “soft patch” is illustrated in Charts 1,2,3 and 4, which contain representative data that will not be revised radically, if at all.

Chart 1

Chart 2

Chart 3

Chart 4

I believe this current weakening in the pace of U.S. economic activity is primarily the result of the past sharp deceleration in the growth of thin-air credit, thin-air credit being defined here as the sum of commercial bank credit and reserves of depository institutions held at the Federal Reserve. As I have argued ad nauseam, there is a positive correlation between lagged values of thin-air credit growth and the growth of economic activity. Chart 5 shows the behavior of thin-air credit in the 12 months ended January 2015 in terms of its three-month annualized growth and its month over year-ago month percent change. There was a noticeable deceleration in the growth of thin-air credit in October, November and December 2014, followed by a sharp re-acceleration in January 2015.

Chart 5

Chart 6 shows the behavior of the two components of thin-air credit in terms of their three-month annualized percent changes.

Chart 6

With the cessation of Fed QE securities purchases in October 2014, the Federal Reserve component of thin-air credit, depository institution reserves held at the Fed, has entered an outright contractionary phase. But at the same time that the Fed’s contribution to thin-air credit has been diminishing, commercial banks’ contribution has been increasing. The acceleration in commercial bank credit in the three months ended January 2015 has largely been responsible for the re-acceleration in year-over-year and three-month annualized growth in total thin-air credit in January 2015.

Barring a sharp deceleration in commercial bank credit in the next several months, a re-acceleration in total thin-air credit growth should be sufficient to extricate the U.S. economy from its current “soft patch”. So, to paraphrase Chance, the Gardener: “Yes, there will be stronger growth in the U.S. economy in the spring.” The current economic-activity “soft patch” likely has the FOMC leaning toward making no monetary policy changes at its June 16-17 meeting. If the pace of economic activity picks up in the second quarter, as I expect, the lag in the reporting of economic data might still stay the FOMC’s hand in June. If I am right about a spring pick-up in the pace of economic activity, however, look for some overt FOMC tightening action at the July 28-29 meeting.

The dramatic retreat in the price of oil and other commodities has muddied the waters for those trying to assess inflation. The world’s central banks, most of which are charged with meeting an inflation target, are among those struggling to gain adequate visibility.

Recently, Bank of England (BoE) Governor Mark Carney laid out some interesting principles to help “look through” current distortions and arrive at the correct perspective. By separating transitory factors from those that are more permanent and drawing a distinction between good disinflation and bad disinflation, he offered a framework for others to follow.

January data on prices for the United Kingdom showed that the headline inflation level was again dragged downward by lower oil and food prices. The increase in Britain’s overall consumer price index (CPI) now stands at a record low of 0.3% over the past year. This reading is likely to turn negative, perhaps as early as next month. Similar developments are being seen in other economies, to a greater or lesser degree.

The BoE fully expects a brief spell of overall deflation and yet does not seem concerned. During the press conference following the quarterly inflation report last week, Carney stressed his belief that a brief period of lower prices is unambiguously good for the British economy and that the United Kingdom is far from falling into pernicious deflation wherein consumer purchases are consistently delayed. How has he arrived at this conclusion and why is the bank seemingly so relaxed?

Firstly, the bank has broken down the CPI into its component parts and studied each individually. An interesting statistic raised during the press conference was that 68% of the components of the U.K. CPI basket are still rising in price, which is in line with historic averages. Further, the year-over-year rate of core inflation (which excludes energy and food prices) rose to 1.4% in January. These are hardly signs of a deflationary spiral.

Secondly, Carney was very careful to distinguish between a temporary fall in the oil price and widespread price changes across the economy, at which point a “good price fall” would become a “bad price fall.” In the former case, a limited period of falling prices for some items adds to consumption and economic momentum. Estimates suggest there is now an extra £10 billion in the British economy that can be spent on goods other than petrol, which will boost growth. And as this occurs, prices will resume a more normal pace of increase.

Thirdly, Carney outlined the underlying strength of the economy as a strong check against broad deflation. In this regard, he pointed to continued declines in unemployment, which he suggests could fall to 5% over his forecast period. The BoE was bullish when it came to wage growth, upping its forecast to 3.5% for 2015. If the cost of labor rises at this rate, a drop in the overall CPI would be very unlikely.

It is partly because of these strong fundamentals that the BoE changed its inflation forecast looking ahead to 2018. CPI growth is set to remain around zero for the rest of this year, but once temporary effects have dissipated and slack in the economy has been reduced, inflation could rise faster than previously anticipated, to just above the 2% target at the end of 2017.

Taking this longer view is the proper perspective for those setting monetary policy. By publishing a higher level for the end of the forecast period, the governor may be subtly trying to change market expectations for a rate hike by shifting focus away from what is happening to prices now and toward the solid recovery.

Other central banks are also attempting to look through temporary price effects. The most recent minutes of the Federal Open Market Committee and the first minutes from the European Central Bank (ECB) governing council meeting reflected concerns about persistently low levels of inflation, prompted in part by the energy price correction.

Forecasts from the Federal Reserve have consistently reflected an expectation that inflation is on its way back toward the long-term target of 2%. If the benefits of low prices for some products add to existing economic momentum, the price level should resume a normal rate of increase after this transitory period of muted growth. And similar to the case in the United Kingdom, service-sector inflation (which makes up 62% of the U.S. CPI) is on a normal track.

The dynamic in the eurozone is more complicated. The ECB proceedings reflected concern that a widening share of goods and services is showing price declines, and underlying economic momentum is insufficient to serve as a check against deflation. As a result, the minutes note that “(T)he Governing Council was not in a comfortable position to ‘look through’ price shocks, even when they originated on the supply side.”

In sum, the inflation construct offered by Governor Carney last week may prove to be a very valuable British export to the rest of the world. One also hopes that Britain’s strong economic performance will prove valuable to its neighbors in Europe.

Oiling the Gears of Consumption

Crude oil prices have declined by more than 50% since June 2014, and gasoline prices in the United States are down roughly 22%. It is widely expected that the benefit from lower gasoline prices should translate into higher consumer spending on other items. Analysts are slicing and dicing data to look for signs of this oil price dividend.

U.S. real consumer spending advanced at a robust 4.3% annualized pace in the fourth quarter, a solid reading that is a testimony to improved economic fundamentals. But the weakness in December and January retail sales after excluding gasoline purchases has many wondering if consumers are saving energy cost reductions for a rainy day.

At first, consumers increase gasoline purchases when prices fall, and this is visible in recent data. In the June-December 2014 period, real gasoline sales rose 3.9%. Households are also inclined to buy new cars, with a preference for bigger vehicles, when gasoline outlays make up a smaller part of the budget. Recent car sales numbers support the view that the reduction in gasoline prices boosted car sales, especially for larger models.

Looking at consumer spending beyond fuel and transportation, data indicate that restaurant sales, a discretionary purchase, recorded the largest six-month increase since 2006. But outside of these primary categories, spending has maintained a more modest upward trend.

Household preferences may be leading to frugality — for now. Personal saving as a percent of disposable income held nearly steady on an annual basis in 2014, while quarterly numbers point to a drop in savings. Many families still have some work to do to pay down debt and rebuild savings, and this may be holding back their willingness to spend their energy cost windfall.

Further, the Permanent Income Hypothesis posits that consumers have a long-term trajectory in mind when they allocate their budget. In this context, if the recent drop in oil prices is seen as a transitory event, a portion of the resulting savings may not be spent. On that front, the University of Michigan Consumer Sentiment survey shows households expecting a 25% increase in gasoline prices during 2015.

However, as time goes on and the sense deepens that gasoline prices will remain lower for longer, gains in consumer expenditures should be more prominent. This would follow the lagged pattern seen in past oil price corrections. If gasoline prices eventually reflect the full correction in crude oil prices, this would also be an accelerant for the economy.

These considerations are included in our forecast of consumer spending for 2015, with the first half showing a stronger performance compared with the latter part of the year. The benefit from lower oil prices is here, but the size is smaller than expected — for now.

So while cheap gas has not produced a very substantial change in consumer behavior yet, this remains an important upside factor in the outlook for 2015.

Audit This

I sit on the same floor as our audit department. It’s a bit nerve-wracking; I am always in fear that one of its members will notice something questionable on my desk and demand a lengthy explanation. Broadly speaking, though, I have immense respect for my partners across the hall; events over the past 25 years have clearly demonstrated the importance of their discipline to the financial system.

Nonetheless, I am adding my voice to the expanding chorus that stands against the “audit-the-Fed” movement. The proposal is a thinly veiled attempt by some in Congress to meddle in monetary affairs, cloaked in the false tunic of the public interest.

The Federal Reserve has attracted a lot of attention since 2008. The series of steps taken to stabilize the financial system and re-establish economic expansion pushed the envelope of central bank authority. As one reflection of this, the Federal Reserve’s balance sheet remains more than five times larger than it was prior to the Global Financial Crisis.

As the owner of about 14% of all U.S. Treasury securities and 24% of U.S. agency-backed mortgage bonds, the Fed has also been generating sizeable cash flow, well beyond what is needed for its functioning. The excess is remanded to the Treasury Department, a practice that produced nearly $100 billion for federal coffers last year.

Such powers and such sums certainly warrant appropriate oversight. To that end, the Federal Reserve is already audited on a number of fronts. Its financial statements are reviewed by one of the “Big Four” accounting firms, and its operations are reviewed by the General Accounting Office (GAO). Having participated in some of the GAO exercises while working at the Fed, I can attest to their depth and objectivity.

Of course, it is not the bookkeeping or the process reviews that interest the Fed’s critics in Congress. Instead, they would like to expand legislative oversight of monetary policy by retrospectively reviewing central bank decisions and the outcomes they produced.

Aside from the bald politics of the proposal, the concept has serious flaws. Decisions made in real-time under uncertainty are hard to judge ex post when all is clear. Further, monetary policy works with long and unpredictable lags; choosing an appropriate time line for review is, therefore, difficult. And finally, economic outcomes are the product of a wide series of domestic and international policies over which the Fed has only limited control.

Structurally, the independence of central banking is a very sacred tenet in the financial world. Excessive government involvement in the process can stress short-term outcomes over long-term goals and raises the prospect of the central bank monetizing public debt. There have been numerous past and present examples from around the world that illustrate these dangers.

Over the past generation, the Federal Reserve has become progressively more open in explaining its actions. Next week, Fed Chair Janet Yellen will deliver the Fed’s semiannual monetary report to the Congress, one of a series of regular efforts to keep the public fully informed.

She is far too polite to be so direct, but many of us would cheer if she parried the calls for greater accountability by turning the mirror back on those who would question her. Now that’s an audit I’d like to see.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

This picture is the story of many investors’ lives, providing they were investing 20-25 years ago. While younger investors may not be able to “feel” the similarities between today’s investor environment and that of the late 1990s buildup to the Nasdaq Composite hitting the 5000 level, those of us who remember it probably remember the feeling. The air was sweeter, the money greener, and a sense of serenity existed which was akin to getting a 2-hour massage…that lasted for years.

Nasdaq 5000 first occurred in March of the year 2000. It is knocking on the door again. At Sungarden, we are not in the prediction business but we ARE in the business of evaluating reward vs. risk tradeoffs. And they are tilting ever so gradually toward higher risk and lower reward for traditional investment approaches. And like what followed Nasdaq 5000 the last time, we would not expect a bell to sound signaling an end to the stock bull market we have had since around this time in 2009. And in our own portfolios, we are still enjoying the ride higher, in our own “hedged investing” way. But caution flags abound. Here is what we see, in reference and deference to that old, great bubble of a market that that ended in early 2000 and, for the Nasdaq Composite Index, marked the start of a 16-year period in which your return was about zilch.

Technology stocks were at the top of minds, media and portfolio weightings. Today they are not called “internet” stocks as they were back then. But ask a novice investor about their portfolio, and the same emerging tech names tend to blurt out.

Private companies are being valued at levels that seem foolhardy to value-oriented investors like us…but we are probably in the minority, and too old and dumb to really understand this new era all of the millennial investors have figured out how to conquer. Hey, where is Stuart, that red-hed kid from the E-Trade commercial from the late 1990s, when you need him (if you get the reference, you definitely remember the dot-com bubble!).

Investing in the stock market still works like it used to on the surface…but the players and forms in which it comes in have changed. ETFs, High-Frequency Traders, Hedge Funds, etc. are all a bigger force than at the time of the first Nasdaq 5000. But investor hubris? That’s still there. The biggest difference is that today, someone’s opinion can be known by millions in a second. Back then, you might find out faster than a newspaper, but only if you had one of those newfangled AOL accounts. Geez, I sound like that guy at Disney’s “Carousel of Progress” ride, don’t I?

One thing that was not the same back then: high-quality bond rates. Back then, 10-year U.S. Treasury Bond yields started with a 6. Today they start with a 2. All that means is that if Nasdaq 5000 turns out to be another last gasp in an over-levered economy, and not the launching pad for a new era of wealth creation, a major cushion for equity investors is gone. That will require a different escape plan for investors. That’s what we are focused on managing here.

The Chinese New Year, which kicks off today, is the largest and most widespread cultural event in mainland China, bringing with it massive consumer spending and gift-giving. During this week alone, an estimated 3.6 billion people in the China region travel by road, rail and air in the largest annual human migration.

Imagine half a dozen Thanksgivings and Christmases all rolled into one mega-holiday, and you might begin to get a sense of just how significant the Chinese New Year festivities and traditions are.

According to the National Retail Federation, China spent approximately $100 billion on retail and restaurants during the Chinese New Year in 2014. That’s double what Americans shelled out during the four-day Thanksgiving and Black Friday spending period.

As I’ve discussed on numerous occasions, one of the most popular gifts to give and receive during this time is gold—a prime example of the Love Trade.

Can’t Keep Gold Down

Most loyal readers of my Frank Talk blog know that China, along with India, leads the world in gold demand. This Chinese New Year is no exception. Official “Year of the Ram” gold coins sold out days ago, and since the beginning of January, withdrawals from the Shanghai Gold Exchange have grown to over 315 tonnes, exceeding the 300 tonnes of newly-mined gold around the globe during the same period.

China, in other words, is consuming more gold than the world is producing.

What’s not so well-known—but just as amazing—is that China’s supply of the precious metal per capita is actually low compared to neighboring Asian countries such as Taiwan and Singapore.

This might all change as more and more Chinese citizens move up the socioeconomic ladder. Over the next five years, the country’s middle class is projected to swell from 300 million to 500 million—nearly 200 million more people than the entire population of the United States. This should help boost gold bullion and jewelry sales in China, which fell 33 percent from the previous year.

“I don’t see demand staying down because you have had structural changes,” commented WGC Head of Investment Research Juan Carlos Artigas in an interview withHard Assets Investor. “One of them, emerging market demand from the likes of India and China, continues to grow, and we expect it to continue to grow as those economies develop further.”

New Visa Policy Promises Increased Chinese Tourism

The Year of the Ram has also ushered in a new visa policy, one that has the potential to draw many more Chinese tourists to American shores.

For years, Chinese citizens could receive only a one-year, multi-entry visa. Now, leisure and business travelers can obtain a visa that allows them to enter multiple times over a 10-year period. The visa application process has also been relaxed.

In terms of overseas spending, Chinese tourists already sit in first place, just above their American counterparts. According to the United Nations World Tourism Organization, a record $129 billion was spent by Chinese travelers in 2013 alone. The average Chinese visitor spends between $6,000 and $7,200 per trip in the U.S.

This visa policy reform is an obvious boon to travel and leisure companies such as those held in our All American Equity Fund (GBTFX)—Walt Disney and Carnival Corp., for examples, not to mention retailers such as Kohl’s, Coach and The Gap.

Other beneficiaries include Chinese airlines such as Air China, which we own in our China Region Fund (USCOX). Global airline stocks are currently soaring as a result of low oil prices, increased seat capacity and more fuel-efficient aircraft. The new visa policy has the potential to give these stocks an even stronger boost.

On a lighter note, at least a couple of airports in North America are making the most of the Chinese New Year, hosting performances by Chinese musical artists and providing entertainment such as a lion dance through the terminal and calligraphy.

To our friends and shareholders here in the U.S. and abroad, I wish you all a Happy Chinese New Year!

Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

Stock markets can be volatile and share prices can fluctuate in response to sector-related and other risks as described in the fund prospectus.

Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.

Fund portfolios are actively managed, and holdings may change daily. Holdings are reported as of the most recent quarter-end. Holdings in the All American Equity Fund and China Region Fund as a percentage of net assets as of 12/31/2014: The Walt Disney Co. 1.16% All American Equity Fund; Carnival Corp. 1.18% All American Equity Fund; Kohl’s Corp. 1.17% All American Equity Fund; Coach, Inc. 1.18% All American Equity Fund; The Gap, Inc. 1.19% All American Equity Fund; Air China Ltd. 1.11% China Region Fund.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

Deep into the US earnings season, the halo from Apple’s shining performance has lit up an otherwise lackluster market. This is no consolation for the rest of the companies in the S&P 500. In this type of market, we believe investors need to be especially discriminating.

The earnings season isn’t quite over yet. But as of February 10, Apple’s fourth-quarter profit growth exceeded those of all the S&P 500 companies that have reported, combined. In aggregate, 347 companies reported a 3% contraction in earnings (Display, left). And the pain was widespread, with more than a third of S&P 500 companies showing year-over-year declines (Display, right)—as some of the biggest companies in the index dragged down aggregate earnings growth.

Bumper Quarter for Apple

Apple had an excellent quarter. It sold almost 75 million iPhones, fueling revenue growth while increasing the average selling price per unit. Strong revenues helped boost earnings by about 50%, through expanded margins as well as fewer shares outstanding due to a stock buyback program. But one healthy Apple—which accounts for about 4% of the index—isn’t really enough to keep the doctor away from the rest of the market.

Other companies reported mediocre results. We believe that several factors—including a strong US dollar, modest global economic growth and potential pressure on wages—are creating challenges for revenue and earnings growth.

Strong Dollar Cuts Revenue

Over the past year, the US dollar has strengthened by more than 10% compared with a basket of currencies. International sales represent about 35% of total S&P 500 revenues. So if the dollar strength persists, we expect it to take a bite of about 3% from overall revenue this year.

Wages are a growing pressure point in early 2015. Excess labor—resulting in modest wage gains—helped to keep profitability elevated over the past five years. But in the February 6 employment report, wage inflation exceeded 2%. If this trend continues or accelerates, it could signal a peak for profit margins.

Mixed Impact from Oil Shock

Low oil prices have had a mixed impact on the market. After plunging by about 50% from a year ago, many energy companies—which account for about 8% of the S&P 500—are feeling the squeeze. For other companies, lower energy costs are likely to help reduce expenses. And consumers will enjoy a windfall from falling energy prices, which should buoy consumer spending—as well as US and global economic growth.

Some argue that underlying profits are actually healthier than they look. We disagree. The dollar and oil shock are real factors and shouldn’t be stripped out of earnings to paint a prettier picture. In our view, investors should ask whether the sluggish earnings season is the start of a bigger trend after six strong years and a recovery of profit margins from 4.5% in 2008 to a record 10% in 2014—and should ask what it means for their portfolios.

Start by thinking about how these complex dynamics will affect diverse companies as the year unfolds. For example, pressure on margins from rising wages could be offset by better revenue growth, as consumers have more disposable income. Since every company will experience this differently, selectivity is becoming increasingly important.

Sector valuations also deserve attention. The US equity market is not a homogenous entity. Utilities and staples look expensive relative to history as the quest for yield has inflated valuations (Display). In contrast, the industrials and technology sectors appear relatively inexpensive given concerns about short-term earnings. This is a good starting point for stock pickers. Within these sectors, we believe there are undiscovered opportunities.

Be Selective

Equities still have an important role to play in investor allocations. With global bond rates at or close to record lows, investors can’t really afford to stay on the sidelines of the stock market to meet their long-term goals. That said, we believe market conditions today demand a more selective approach, as opposed to the last few years, when a diversified approach was rewarded.

With earnings growth more difficult to find today, owning a few select names is preferable to owning 500 companies via an index, in our view. In particular, we believe that companies with exposure to secular growth drivers, which are relatively uncorrelated with macroeconomic conditions, have the best chance of delivering superior results.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

James T. Tierney, Jr, is CIO – Concentrated US Growth at AB (NYSE:AB).

One investment call that most investors, myself included, got wrong last year was predicting interest rates would go up. This time around, while U.S. long-term yields have rebounded from their January lows, rates have generally been lower than where they ended 2014, calling into question: Will long rates stay low and defy expectations again in 2015? I think that is unlikely. I expect the 10-year U.S. Treasury yield higher a year from now.

Before we talk about why I think interest rates would rise, it helps to revisit some of the reasons behind the 10-year U.S. Treasury note being stuck at yielding a low 2%.

Lackluster global growth. Many economies have been struggling with well below average growth and inflation. While this phenomenon is most common among developed economies, some emerging markets also suffered from it: for example, China’s headline inflation rate recently dipped below 1%. Slow growth has led to ultra-low and often negative yields in much of the developed world, making U.S. fixed income more attractive in relative terms, even as the U.S. economy strengthens. With yield an ever-scarcer commodity, relatively high rates that U.S. bonds offer alongside a strong U.S. dollar are attracting global capital flows and pushing bond prices higher and yields lower.

Low supply, high demand. Put simply, there are not enough bonds to go around. Consumers have reined in their borrowing and governments have tried to moderate spending, which means fewer bonds have been issued. Despite the much talked about “Great Rotation” into stocks, institutional and retail investors continued to have strong appetite for bonds. Also, with central banks outside the United States undertaking large scale buying of bonds through quantitative easing, demand for bonds will probably stay high for some time.

No price growth. Although the U.S. economy accelerated last year and job creation surged, wage growth remains muted and commodity prices are plunging. This means that even in the U.S. expectations for future inflation are unusually low.

Given these market dynamics, why expect higher interest rates? Because some of these conditions are starting to change.

A nascent rise in inflationary expectations. From my vantage point, oil is likely to stabilize and inflation could return to more normal levels in the back half of 2015, pushing inflation expectations to come up from today’s very low levels. There are signals that this is already happening. Inflation expectations embedded in the 10-year Treasury Inflation-Protected Securities (TIPS) have rebounded from 1.50% in January to 1.70% today. If expectations move back toward 2%, closer to the Federal Reserve’s (Fed’s) target, this will translate into upward pressure on long-term rates.

The Fed’s “liftoff.” As we get closer to the Fed raising its benchmark rate later this year, interest rates will probably move higher. A measured tightening pace is expected, and most of the pressure will be on the short end of the yield curve. However, long-term rates will still be affected.

A strong U.S. economy. We are seeing increased credit demand from businesses and, to a lesser extent, from households as economic conditions improve in the United States. Higher demand for capital will buoy rates.

The bottom line: While we still expect the low-yield world to persist throughout 2015 and probably next year as well, U.S. long-term interest rates are likely to gradually climb back to where they were early last year… just when everyone got it wrong.

Source: Bloomberg

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock.

This material represents an assessment of the market environment as of the date indicated and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security in particular.

NEW YORK – When the euro crisis began a half-decade ago, Keynesian economists predicted that the austerity that was being imposed on Greece and the other crisis countries would fail. It would stifle growth and increase unemployment – and even fail to decrease the debt-to-GDP ratio. Others – in the European Commission, the European Central Bank, and a few universities – talked of expansionary contractions. But even the International Monetary Fund argued that contractions, such as cutbacks in government spending, were just that – contractionary.

We hardly needed another test. Austerity had failed repeatedly, from its early use under US President Herbert Hoover, which turned the stock-market crash into the Great Depression, to the IMF “programs” imposed on East Asia and Latin America in recent decades. And yet when Greece got into trouble, it was tried again.

Greece largely succeeded in following the dictate set by the “troika” (the European Commission the ECB, and the IMF): it converted a primary budget deficit into a primary surplus. But the contraction in government spending has been predictably devastating: 25% unemployment, a 22% fall in GDP since 2009, and a 35% increase in the debt-to-GDP ratio. And now, with the anti-austerity Syriza party’s overwhelming election victory, Greek voters have declared that they have had enough.

So, what is to be done? First, let us be clear: Greece could be blamed for its troubles if it were the only country where the troika’s medicine failed miserably. But Spain had a surplus and a low debt ratio before the crisis, and it, too, is in depression. What is needed is not structural reform within Greece and Spain so much as structural reform of the eurozone’s design and a fundamental rethinking of the policy frameworks that have resulted in the monetary union’s spectacularly bad performance.

Greece has also once again reminded us of how badly the world needs a debt-restructuring framework. Excessive debt caused not only the 2008 crisis, but also the East Asia crisis in the 1990s and the Latin American crisis in the 1980s. It continues to cause untold suffering in the US, where millions of homeowners have lost their homes, and is now threatening millions more in Poland and elsewhere who took out loans in Swiss francs.

Given the amount of distress brought about by excessive debt, one might well ask why individuals and countries have repeatedly put themselves into this situation. After all, such debts are contracts – that is, voluntary agreements – so creditors are just as responsible for them as debtors. In fact, creditors arguably are more responsible: typically, they are sophisticated financial institutions, whereas borrowers frequently are far less attuned to market vicissitudes and the risks associated with different contractual arrangements. Indeed, we know that US banks actually preyed on their borrowers, taking advantage of their lack of financial sophistication.

Every (advanced) country has realized that making capitalism work requires giving individuals a fresh start. The debtors’ prisons of the nineteenth century were a failure – inhumane and not exactly helping to ensure repayment. What did help was to provide better incentives for good lending, by making creditors more responsible for the consequences of their decisions.

At the international level, we have not yet created an orderly process for giving countries a fresh start. Since even before the 2008 crisis, the United Nations, with the support of almost all of the developing and emerging countries, has been seeking to create such a framework. But the US has been adamantly opposed; perhaps it wants to reinstitute debtor prisons for over indebted countries’ officials (if so, space may be opening up at Guantánamo Bay).

The idea of bringing back debtors’ prisons may seem far-fetched, but it resonates with current talk of moral hazard and accountability. There is a fear that if Greece is allowed to restructure its debt, it will simply get itself into trouble again, as will others.

This is sheer nonsense. Does anyone in their right mind think that any country would willingly put itself through what Greece has gone through, just to get a free ride from its creditors? If there is a moral hazard, it is on the part of the lenders – especially in the private sector – who have been bailed out repeatedly. If Europe has allowed these debts to move from the private sector to the public sector – a well-established pattern over the past half-century – it is Europe, not Greece, that should bear the consequences. Indeed, Greece’s current plight, including the massive run-up in the debt ratio, is largely the fault of the misguided troika programs foisted on it.

So it is not debt restructuring, but its absence, that is “immoral.” There is nothing particularly special about the dilemmas that Greece faces today; many countries have been in the same position. What makes Greece’s problems more difficult to address is the structure of the eurozone: monetary union implies that member states cannot devalue their way out of trouble, yet the modicum of European solidarity that must accompany this loss of policy flexibility simply is not there.

Seventy years ago, at the end of World II, the Allies recognized that Germany must be given a fresh start. They understood that Hitler’s rise had much to do with the unemployment (not the inflation) that resulted from imposing more debt on Germany at the end of World War I. The Allies did not take into account the foolishness with which the debts had been accumulated or talk about the costs that Germany had imposed on others. Instead, they not only forgave the debts; they actually provided aid, and the Allied troops stationed in Germany provided a further fiscal stimulus.

When companies go bankrupt, a debt-equity swap is a fair and efficient solution. The analogous approach for Greece is to convert its current bonds into GDP-linked bonds. If Greece does well, its creditors will receive more of their money; if it does not, they will get less. Both sides would then have a powerful incentive to pursue pro-growth policies.

Seldom do democratic elections give as clear a message as that in Greece. If Europe says no to Greek voters’ demand for a change of course, it is saying that democracy is of no importance, at least when it comes to economics. Why not just shut down democracy, as Newfoundland effectively did when it entered into receivership before World War II?

One hopes that those who understand the economics of debt and austerity, and who believe in democracy and humane values, will prevail. Whether they will remains to be seen.

Deflation, I’m sure, has been around since the dawn of man, though records going back past a thousand years are spotty, at best. Increased supply relative to demand or an abrupt shift in consumption always generates some form of price reduction. The root cause of the European Central Bank’s finally acting on its intention to begin quantitative easing is a direct result of deflation taking root in Europe. This call to action is quite pronounced considering the anxiety that the European region has regarding any uptick in prices due to historical ravaging from inflationary pressures.

Deflation is a widely used term in financial circles; however, its popularity is dwarfed by that of its brother, inflation. The average citizen is probably unconcerned about deflation and would probably be in favor of an environment that has falling prices every month. This positive mood is contingent obviously on income staying the same or rising, which cannot occur should prices and corporate profits be under pressure every month. Consider the inflationary degree of the use of “deflation” in the headlines. So far, we are on track to use “deflation” in headlines by a whopping 350% more in 2015 than 2014.

First, let’s attempt to define deflation; since knowing the term and comprehending the concept are two completely different things. There are many great ways to define it: “a period of declining prices, a lack of induced consumption based upon being rewarded for patience, a fearful pragmatic consumer more concerned with the future than the present.” All of these definitions work to some degree; however, the best technical definition I’ve heard was from Morgan Stanley: “…The origin of global deflationary pressures is an excess of desired savings over desired investment.” This describes the current form of deflation almost perfectly considering the coordination of global central banks to inject liquidity into nearly every corner of the globe to inflate assets. There are several forms of deflation (which we won’t really delve into here) such as price, credit, asset and currency. As we see it, there are at least two ingredients required for deflation: a supply-and-demand imbalance and a permeating and dominant form of fear.

The reason deflation is the “boogeyman” to economists is the psychological cycle that is set forth. The world is currently in the throes of deflationary pressures, especially in Europe and Asia. It is important to understand that this perspective is relative, as deflationary pressures for one country might appear as inflationary or disinflationary to another country.

The most well-known and recent bout of deflation has been in Japan which has been in the throes of deflation for nearly 25 years. During that timeframe, a once thriving and soon-to-be-dominant economy slipped to a distant third behind the United States and China. Japan’s decline is multi-faceted and only spells out the difficulty in pulling a country out of this vicious cycle.

For further evidence, consider the impact on yields; look at what has happened in Germany and the United States over the last 15 years. The two historical curves are derived from taking the average yields over the last 15 years and compared to current levels. Your eyes are not deceiving you, yields on the German Bund market are actually negative and the 10-year currently yields 0.46%. You could not only get a return of 0.46% annually on 10 years, but is also denominated in euros, which have lost 27% from its all-time highs and appears to be on track to lose another 10%. That combination only helps if a client is in dire need of tax losses.

Deflation is the dirtiest of “D words” for economists as it seems to defy logic, especially in free market systems where supply-demand balance is orchestrated on large changes in consumerism and corporate desire for profits. However, the culture issue must come into play when looking at cross-country comparisons. The duration of the current deflationary environment, at least domestically, appears to lie in the wage pressure that is slowly building in the system. History has shown that when output gaps shrink, demand for product increases the need for more skilled labor and employment slack begins to unwind, wage pressure can often spike and then slows to a more acceptable pace.

With consumption numbers showing resilient growth and an increased backstop in the form of balance sheet liquidity and net worth, the United States’ deflation experience may not be similar to the ones currently seen in Europe or in Japan. Deflationary and inflationary cycles always have momentum that maintains a trend long after the pressures may be abating. They also have some lagging components. Once the general public begins to use the new lexicon, it often begins its move toward the exit, allowing its antithesis to enter. Buying inflationary protection is very counterintuitive and cheap, two qualities we look for in all value-oriented plays. We believe investors should consider some positions in inflationary-protected assets.

Deflation doesn’t just impact economics and markets, but now we see it encroach on New England Patriots’ game preparation who have fully embraced deflation.

CRN: 2015-0121-4577RThis commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.

[description] => Deflation has been around ever since there was an excess supply of something or when demand had plummeted. The term “deflation” has now become mainstream in the general public’s lexicon, though the understanding of the declining economic growth that corresponds with it is often disregarded until it wreaks havoc on the consumer’s paycheck. When we see deflation permeating global economics, market movements and NFL games, the general public will become acutely aware of the other major impact from deflation, the increasing symbiotic nature of all the global economies. The Butterfly Effect of Chaos Theory is perhaps more impactful than at any time in history.
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[title] => Connecting the Dots: Procter & Gamble, the Strong Dollar, and Pepto Bismol
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What do those household-name companies have in common? Not much, other than that a huge part of the sales come from outside the US.

Really, really huge.

Collectively, the 500 companies in the S&P 500 get 46% of their sales and roughly 50% of their profits from outside the US. They are truly multinational giants.

Expanding your customer base is always a good thing, but doing business overseas is not without peril, and one of the underappreciated perils is the impact of currency movements. A stronger dollar can hurt companies that do a large share of their business overseas because sales in other countries translate back into fewer dollars.

Just ask Procter & Gamble, which reported their Q4 results last week.

P&G sold $20.16 billion of toothpaste, laundry detergent, diapers, toilet paper, and razor blades last quarter, but that was a 4% decline from the same period a year ago.

Worse yet, profits plunged by 31% to $1.06 per share, which was not only well below the $1.13 per share Wall Street was expecting but also a horrible 31% year-over-year drop. That’s bad.

What’s behind those terrible numbers? The US dollar.

“The October-December 2014 quarter was a challenging one with unprecedented currency devaluations,” said CEO A.G. Lafley.

The US Dollar Index was up 13% in 2014 and is now near a 9-year high. That strong dollar is a big millstone around the neck of US exporters, whose products are now more expensive for foreign buyers as well as negatively affecting profits once those foreign sales are converted back into US dollars.

Worse yet, Lafley said the environment will “remain challenging” in 2015.

The US dollar is now at a 9-year high and threatening to go higher. Much, much higher.

By historical standards, the US dollar is still cheap and expected to go higher by many observers, including Procter & Gamble.

P&G warned Wall Street that its 2015 sales will fall by another 5% and its 2015 profits will shrink by another 12%.

Think about those two numbers: 5% lower sales and 12% lower profits.

The strong dollar is a big problem for P&G because it gets roughly two-thirds of its revenues from outside the US, so it’s more affected by the strong US dollar than most companies, but P&G is far from alone when it comes to currency woes.

The line of companies that have warned that the strong dollar is hurting their profits is getting longer and longer.

Microsoft, Pfizer, McDonald’s, Caterpillar, United Technologies, Emerson Electric, 3M, and even Walmart have warned that the rising dollar is depressing their profits.

What does this mean to you? That a LOT more companies are going to report lower-than-expected sales and profits in 2015 and those that do will see their stock get hammered, just like P&G.

The problem is that Wall Street is blind to this profit-crushing trend.

In 2014, the S&P 500 companies collectively earned $117.02, and the median forecast of Wall Street strategists for 2015 S&P 500 earnings is $126, which is an optimistic 7.6% growth in earnings.

Unless you think that Procter & Gamble is an isolated island of trouble (and it’s not), you should be very worried that Wall Street is grossly underestimating the profit-crushing impact of the strong dollar as well as grossly overestimating corporate America’s earnings growth.

That massive disconnect between reality and the Wall Street dream world is going to translate into some very tough times for stock market investors. If you haven’t added some defense to your portfolio… you may need lots and lots of a popular Procter & Gamble product: Pepto Bismol.

Tony Sagami

30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

Stites on Estates took an interesting look at retirement intentions versus retirement reality along with a reiteration of the dismal statistics about how little savings people who are working have accumulated as well as how few dollars people have put away when beginning their retirement.

First, their table with the numbers of people still working.

Then their table with numbers of people who are retired;

My hunch is that people will look at the tables and either feel good about perhaps being in the $250,000 category or they will be glad they are not the only ones in the $10,000 or less category, in fact they have a lot of company.

The above is data that you have seen before in one form or another. The other point made that is discussed less frequently is how common it is for people to plan to work into their late 60’s or early 70’s only to “retire” much sooner. I put retire in quotes there because people run into health problems that force their hand or their company runs into trouble that results in job cuts.

There are other two tables in the article that address this and they show that 35% of the people who retired in 2014 were 60 or younger and that 32% were between 60 and 64. This compares with 9% younger than 60 and 18% between 60 and 64 who expected to retire at those ages.

It is unclear whether there is any overlap of people but the tables are clear about a dispersion between expectations and reality and the consequence can be significant. It is easy to envision the scenario of someone who in their 40’s and 50’s saved a little for retirement but was more focused on their mortgage and kid’s college expenses who planned to crank up the savings rate in their 60’s and mortgage free with the intention of working until 70. Embedded in that scenario might also be the expectation for generally rising wages all the way through.

Part of retirement planning is the possibility that whatever you have in mind changes from the top down (something with your company or job) or the bottom up (your interests change or your hand is forced for health or family reasons).

If you’re reading this blog then you’re more likely to be in some of the higher categories for how much you have saved or you provide service to clients who are more likely to be in the higher categories. In that case you have some sort of plan for yourself or plans for your clients so what happens if planning for 68 becomes go time at 59? Being lucky enough to be in the $250,000 or more category doesn’t necessarily mean you are financially ready to retire nine years early. I would also add that while $250,000 may not seem like a large sum for this audience the numbers show that very few people have that much saved and so there is at least some element good fortune.

Ultimately a 60 year old who is 2/3rds of the way to their number who is forced to “retire” early will simply have to figure it out one way or another and that might be a scenario that is plausible for this audience versus having nothing saved. Someone who is 55 with $800,000 accumulated, believing they need $1.3 million at 64 who is then forced out of their job is certainly not ruined but they will need to figure a few things out.

This past weekend the Incident Management Team that I am on (this is a fire department thing) was part of the contingency plan for the Sedona Marathon in case the event turned into some sort of big emergency incident. I’m the Logistics Section Chief (trainee) and I spent the last couple of weeks arranging all sorts of resources we would need to call in if something had happened (it didn’t). I am still learning of course but a lot of bases were covered.

I think there is an obvious parallel to contingency planning for your retirement expectations. In terms of emergency preparation the marathon went smoothly but not every event does. Likewise not every retirement plan can go smoothly. Having something unexpected occur is beyond your control but having a contingency plan that covers a lot of bases is within your control.

Last week a scene unfolded in Athens, largely unnoticed by American eyes, that provided all the visual and metaphorical symbols needed to define the current state of the global economy. Hollywood's best screenwriters couldn't have laid it out any better.

Tiring of being told by self-righteous foreigners to pay for past borrowing with current austerity, the Greek people had just elected the most radically left-wing government in recent memory, whose stated goal was to tell their creditors that they were not going to take it anymore. The leadership of the victorious Syriza Party, a collection of mostly young Marxist and Trotskyite academics, had promised the Greek people a clean break from the past and an end to years of economic malaise. Although their plan seemed fundamentally contradictory (telling foreign creditors to butt out even while courting more aid), Syriza nonetheless appealed to a frustrated electorate through their dynamism and optimism.

To show that they were not just another upstart coalition that would co-opt the status quo once elected, Syriza leaders adopted the posture, vocabulary and clothing of revolutionaries. Throughout his campaign, Alex Tsirpas, the new prime minister, refused to wear a tie, thereby eschewing the most potent symbol of traditional power. When sworn in as prime minister, also with an open collar, he dispensed with the "hand on the bible" ceremony and instead invoked the spirit of fallen Greek Marxists. Since the election Syriza leaders have hot toned down their rhetoric as many predicted they would. Could it be that they actually meant what they said?

Syriza's fiery attitude has put Greece on a collision course with northern European leaders who face the political necessity of requiring Greece to repay previously delivered bail out money. In this context the first meeting between Yanis Varoufakis, the newly installed Greek Finance minister and Jeroen Dijsselbloem the Dutch representative of the so-called "troika" of lenders (The European Central Bank, the International Monetary Fund, and the European Commission), was bound to produce some drama. The meeting exceeded expectations on that front. But how it looked was perhaps more important than what was said.

In a room packed with cameras and reporters, Varoufakis strode in not just tieless and open collared, but with his shirt shockingly untucked. He ambled to his chair, and sat slouching backwards with his legs crossed like a poker player barely able to contain the glee of a winning hand. His expressions were effusive, satirical, and defiant. All he lacked were sunglasses and a couple of groupies to complete the rock star persona. To his right sat the stiff necked, buttoned-down Dutchman, who in in the words of Colonel Kurtz appeared like "an errand boy, sent by grocery clerks, to collect a bill."

The two agreed on seemingly nothing. Dijsselbloem insisted that the new Greek government live up to the austerity and repayment commitments, and Varoufakis said that the Greeks would no longer negotiate with the creditors who he believed were responsible for his country's destitution. When there was really nothing left to say, the meeting came to an abrupt end and the two executed a painfully awkward handshake. Dijsselbloem, seeming annoyed, avoided eye contact with his counterpart and left the room without looking back. On the other hand, Varoufakis, seemingly enjoying the moment, shrugged his shoulders and smiled for the cameras, as if to say "What's up with the stuffed shirt?"

What could explain these contrasting attitudes? Shouldn't the creditor, the one lending the money, and the party who will be asked for more, be in the power position? Shouldn't the borrower be in position of supplication? If you thought that, you don't understand the current way of the world. Based on the ascendancy of Keynesian "demand side" economics it is the borrower who is considered the key driver of growth. The theory holds that if the borrower stops borrowing they will also stop spending. When that happens they believe the entire economy collapses, dragging down both lenders and borrowers in the process. From that perspective, the bigger the borrower the greater his importance, and the more leverage he has with the lender. This is like the old adage: "If you owe the bank $10, that's your problem. But if you owe the bank $10 million dollars, that's the bank's problem."

Syriza knows that northern European leaders are terrified at the prospect of disintegration of the EU and the stability it provides. The goal of maintaining open and essentially captive markets for German manufacturers was the prime reason that pried open Berlin's wallet in the first place. But Syriza also understands the power that debtors have in today's world. Default leads to liquidations, which in turn leads to deflation, the biggest bugaboo in the Keynesian night gallery of economic fears. After years of bailouts of banks, corporations, and governments, debtors know that no one is ready to risk another Lehman Brothers type collapse on any level. The bar of "Too Big to Fail" has gotten progressively lower. If Greece can repudiate its debts, the temptation for larger indebted nations like Italy and Spain to do the same will be ever greater.

This understanding fuels not only the swagger of the Greek finance minister but also the attitude of the world's largest debtor, the United States of America. Although the $1 Trillion dollar plus annual budget deficits have been cut significantly in recent years (thought the national debt has exploded beyond $18 trillion), I believe the reduction is largely a function of the asset bubbles that have been engineered by the Fed's six year program of quantitative easing and zero percent interest rates. Any sustained economic downturn could immediately send the red ink back into record territory. But flush with his victory speech/State of the Union address, President Obama has adopted a bit of the Varoufakis bravado.

President Obama's newly unveiled 2015 budget includes almost $500 billion in new spending; effectively dispensing with the token austerity that Washington had imposed on itself with the 2011 "Sequester." In my opinion, the U.S. has virtually no hope of paying for all of our spending through taxation, the budget busting proposals should be viewed as a message to our foreign creditors that we plan on borrowing plenty more, and that we expect that they will keep lending for as long as we want. From a global economics perspective the United States is like Greece writ very, very large. Much like the Northern European countries, the major exporting nations around the world are terrified that their economies would be shut out of U.S. markets if their currencies were to strengthen against the dollar. I believe this has allowed America to approach its finances with impunity.

But this confidence may be leading to trouble. If the new Greek government keeps following its current course, it may ultimately be shown the door of the Eurozone. Although a "Grexit" may ultimately pave the way for a real Greek recovery, the Greeks themselves should have no illusions about how painful this journey may be. Without the purchasing power of the euro and the largesse of the creditors supporting them, the Greeks may find themselves with a basket case currency that delivers far lower living standards. If Greek government employees thought austerity was bad when it was imposed from Brussels, wait until they see how bad it's going to be when imposed by Athens. In fact, no Greek recovery will be possible until the newly elected Marxists become unapologetic capitalists.

When the Swiss National Bank decided to abruptly reverse course on its euro peg, the world should have been treated to a fresh lesson at the finite nature of creditor patience. While this message may have been lost on most observers, sooner or later this reality will sink in. When it does, the shirts will be tucked, the ties will be fastened, and knees just may start bending.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

The steep fall in international oil prices has significantly altered the economic prospects of most countries in the region in recent months. While consumers across the region are likely to gain from cheaper pump prices, the U.S. and Canada are expected to see the most improvement in domestic demand. U.S. consumer sentiment has surged recently, as the stronger labor market has also helped make consumers more optimistic. However, lower oil prices are likely to be a net negative for Canada as the country is already seeing a decline in energy exports. The Canadian labor market has also weakened recently as energy sector companies have started reducing their workforces and scaling back new investments.

In Latin America, Brazil is expected to see a stagnant economy in 2015 as well. The country’s trade account slipped into a deficit in 2014, as prices of major exports such as iron ore declined. Subdued demand from China and recession in neighboring Argentina hamper the export prospects for Brazil this year. For Mexico, the negative effect of lower oil prices is likely to be more contained as the country’s hedging policy limits the decline in government revenues. Stronger U.S. demand for manufactured goods should help Mexico offset the potential job losses in the energy sector. Colombia has launched additional fiscal stimulus to counter the losses from oil exports. The export prospects of Chile and Peru have dimmed as copper prices slipped further this month, but both countries are rolling out fiscal and monetary measures to help domestic demand.

At a Glance

United States: Helped by the steep fall in fuel prices and exceptionally low borrowing costs, the U.S. economy appears to have entered a phase of healthy growth. The pace of expansion for the second and third quarters of 2014 exceeded expectations, and most data points remained positive during the last quarter as well. The World Bank now expects the U.S. economy to grow 3.2 percent this year, which would be the fastest growth among developed countries.

Canada: The decline in oil prices could reduce the pace of Canada’s economic growth in 2015, but the country’s economy is likely to remain relatively healthy. Rising U.S. consumer demand should benefit the manufacturing sector in Canada’s central region. The Canadian dollar has declined nearly 10 percent against the U.S. dollar, which should help improve the price competitiveness of Canadian manufacturers.

Brazil: Weak external demand continues to challenge the Brazilian economy as the country reported a trade deficit in 2014, its first in over a decade. Exports declined more than expected in December, the fall accentuated by the continuing weakness in commodity prices. A meaningful improvement in export outlook is not expected in 2015 as demand from some of Brazil’s major trade partners is likely to remain low.

Mexico: While the Mexican economy will likely be negatively affected by lower oil prices, the decline should not be as severe as some of the other energy exporting countries. Nevertheless, lower oil prices could lead to job losses in the country’s energy sector and delay the much awaited reforms. At the same time, stronger U.S. consumer demand continues to lift the outlook for exports of manufactured goods from Mexico.

Chile: The outlook for the Chilean economy has deteriorated as copper prices have slipped further at the start of 2015. Copper prices have declined nearly 25 percent from the beginning of last year, denting the export prospects of Chile, which is the world’s leading producer. However, an increase in government spending has supported domestic demand and has lowered the unemployment rate in recent months.

Peru: The Peruvian economy slowed significantly during 2014 as international commodity prices weakened and the trend is expected to continue in 2015 as well. The pace of economic expansion dropped below 3 percent for the first nine months of 2014, compared to 5.8 percent for the previous year. To prevent further economic decline, the government announced a fiscal stimulus package and is increasing infrastructure spending this year.

Colombia: Though Colombia is one of the major oil exporters in Latin America, its government is confident that lower oil prices will not lead to a sharp decline in 2015 GDP growth. While acknowledging that the fall in oil export revenues could bring down the growth rate this year, when compared to 2014, the government believes the country’s diverse economy will limit the downside

UNITED STATES: ECONOMY GAINS PACE AS CONSUMER SENTIMENT STRENGTHENS

Helped by the steep fall in fuel prices and exceptionally low borrowing costs, the U.S. economy appears to have entered a phase of healthy growth. The pace of expansion for the second and third quarters of 2014 exceeded expectations, and most data points remained positive during the last quarter as well. As the domestic environment is expected to remain favorable, the World Bank and other forecasters have lifted their estimate for U.S. GDP growth in 2015. The World Bank now expects the U.S. economy to grow 3.2 percent this year, which would be the fastest growth among developed countries.

Though retail sales for the month of December were below expectations, U.S. consumer sentiment has continued to rise in recent months. An index of consumer sentiment measured by the University of Michigan is now at its highest level in over a decade. Average gasoline prices in the country are now at a five-year low and should result in meaningful cost savings for most households. As there are no major elections or policy changes to upset sentiment, it is now widely expected that consumers will spend their fuel savings on other goods and services.

Further gains in the labor market could provide an additional boost to consumer demand, if wage growth also picks up in the coming months. Average monthly job additions during the second half of 2014 were above expectations, and the most since the 2008 financial crisis. The unemployment rate has also slipped to a multiyear low, though wage growth has been only marginal so far. Average wages could increase at a faster pace as the market tightens this year. However, select states such as Texas and North Dakota where oil production was the major driver of labor market gains in recent years could see job losses if oil prices remain low for an extended period.

While mortgage rates have slipped further, it is unlikely that the U.S. housing market will sustain the growth pace in 2015. Slower construction activity after the housing market decline has reduced current supplies, and builders have also been more cautious in building inventory. This has resulted in rapid price gains in some of the most active markets, and many potential buyers have been priced out. In addition, despite the recent efforts by federal agencies to reduce the down payment for mortgages, credit standards remain tighter than they were before the crisis.

The Federal Reserve is widely expected to start hiking its target rate during the second quarter of this year. However, declining consumer prices and further weakness in global economic conditions could delay the rate hike to later in the year. In the statement released after the December meeting, the Fed was more optimistic in its economic growth outlook. At the same time, the statement also detailed concerns about risks to global growth.

CANADA: GROWTH RATE TO MODERATE ON LOWER OIL EXPORT REVENUES

The decline in oil prices could reduce the pace of Canada’s economic growth in 2015, but the country’s economy is likely to remain relatively healthy. Oil production in Canada’s northern region is likely to fall as the cost of production, especially from oil sands, is much higher than for other methods of extraction. Crude oil exports declined nearly 10 percent in November from a year ago, in revenue terms. Canadian oil producers have not yet reduced production, but could be forced to do so if prices remain low in the coming months. In any case, new investments in oil exploration and production are likely to fall as producers look for cost savings.

However, rising U.S. consumer demand should benefit the manufacturing sector in Canada’s central region. The Canadian dollar has declined nearly 10 percent against the U.S. dollar, which should help improve the price competitiveness of Canadian manufacturers. Lower fuel prices could also boost domestic consumption in Canada, and help both the manufacturing and services sectors. However, domestic demand is likely to remain restricted in the short term as the country’s job market has weakened. The economy lost jobs in November and December, and the unemployment rate worsened marginally. Retail sales in October were nearly unchanged from the previous month.

The Bank of Canada continues to maintain its benchmark rate unchanged, though the bank has become less optimistic about the growth outlook. However, even after the strong rebound in recent years, the country’s housing market remains buoyant. Average home prices for 2014 rose nearly 7 percent through November, easily outpacing the gains for the previous year. The central bank has repeatedly stated its concerns about price gains in the housing sector, which the bank estimates is overvalued by 20 percent to 30 percent. However, if the labor market weakens further and wage gains stall, the housing market could also be negatively affected even if mortgage rates remain at record lows.

BRAZIL: ECONOMIC GROWTH TO REMAIN STAGNANT ON WEAK COMMODITIES

Weak external demand continues to challenge the Brazilian economy as the country reported a trade deficit in 2014, its first in over a decade. Exports declined more than expected in December, the fall accentuated by the continuing weakness in commodity prices. A meaningful improvement in export outlook is not seen in 2015 as demand from some of Brazil’s major trade partners is likely to remain low. Though economic growth in China, the largest importer of Brazil’s goods, has stabilized, its demand for commodities is yet to see a rebound. Meanwhile, Brazil’s neighbor and third largest trade partner Argentina is in a recession and shipments to that country are likely to decline further. Subdued export demand has also dragged down industrial output in recent months.

Nevertheless, domestic demand has so far been relatively healthier as retail sales expanded at a moderate pace in October and November of 2014. Still, some of the gains were likely due to year-end sales promotions, and spending cuts by the government could limit consumer demand in 2015. To regain investor confidence, the Brazilian government has promised to reduce the fiscal deficit by controlling public spending. The government announced cuts in pension and unemployment benefits, and also reduced the subsidy on loans from a state-controlled development bank. In addition, the government has also said it could reverse some of the tax cuts to raise additional revenues.

The economic growth forecast for 2015 has been lowered to 0.4 percent, according to a survey of economists by Brazil’s central bank. Higher than expected inflation and the currency decline forced the central bank to hike interest rates in December. Inflation at the end of 2014 was close to the 6.5 percent upper end of the central bank’s target range. Further rate hikes are expected this year as the central bank remains cautious of rising inflation expectations. Rating agencies Standard & Poor’s and Moody’s have lowered their outlooks for Brazil, citing weak growth and the wide fiscal deficit.

While the Mexican economy will likely be negatively affected by lower oil prices, the decline should not be as severe as some of the other energy exporting countries. Unlike other energy producing countries, Mexico has a policy of protecting its oil revenues from large price swings through hedging. Despite the upfront costs, this policy worked in the country’s favor during the last oil price decline after the global financial crisis. Credit rating agency Moody’s believes the Mexican government has secured its budgeted revenue receipts for 2015 from oil production through hedging. Hence, despite the expected fall in oil export revenues in 2015, Moody’s has not lowered its outlook for the country.

Nevertheless, lower oil prices could lead to job losses in the country’s energy sector and delay the much awaited reforms. Like other oil producers, Mexico’s government-owned energy company is expected to reduce new investments. As a result, the oil field service companies have reportedly started cutting their workforces in the country. The Mexican government has been trying to reform the energy sector by opening up exploration and production to foreign companies. Lower prices are likely to dull the interest of foreign companies in Mexican energy assets.

At the same time, stronger U.S. consumer demand continues to lift the outlook for exports of manufactured goods from Mexico. Though exports in November declined from the previous month, the overall trend remains positive. Automobile exports from Mexico surged to a new record in 2014, according to an auto industry group, after shipments to the U.S. increased more than 20 percent in December. The Bank of Mexico continues to hold its benchmark rate at a record low, but the bank has indicated the possibility of a rate hike in 2015 should the U.S. Federal Reserve start increasing interest rates.

CHILE: FALL IN COPPER PRICES WEAKENS ECONOMIC OUTLOOK

The outlook for the Chilean economy has deteriorated as copper prices have slipped further at the start of 2015. Copper prices have declined nearly 25 percent from the beginning of last year, denting the export prospects of Chile, which is the world’s leading producer. Total mineral exports from the country during 2014 were the lowest in four years and a quick recovery is unlikely as global industrial demand remains subdued. The country’s central bank has estimated that the economy expanded 1.7 percent last year, but is more hopeful for 2015 when the bank expects growth of 2.5 percent to 3.5 percent.

An increase in government spending has supported domestic demand and has lowered the unemployment rate in recent months. Chile’s jobless rate declined to 6.1 percent in November, as the loss of jobs in the mining sector was offset by increased hiring in sectors such as healthcare and other services. The government had announced a nearly 10 percent increase in public spending for 2015, to be funded by higher taxes.

Meanwhile, the central bank continues to hold its benchmark rate steady as wage growth remains robust. Though consumer prices declined in December, the strengthening labor markets pushed up average wages by 7 percent in November, from a year ago. However, according to the survey of economists and traders conducted by the central bank, the benchmark rate is likely to be lowered further during the first half of 2015.

PERU: FISCAL AND MONETARY STIMULUS TO COUNTER WEAK EXPORT DEMAND

The Peruvian economy slowed significantly during 2014 as international commodity prices weakened and the trend is expected to continue in 2015 as well. The pace of economic expansion dropped below 3 percent for the first nine months of 2014, compared to 5.8 percent for t